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JOHN YDSTIE, host:

Dealing with the subprime lending crisis of the past couple of weeks has been the biggest test for Federal Reserve Chairman Ben Bernanke since he took office 18 months ago. We're going to look at how he's handling it, and how the turmoil in the mortgage market is playing out in the political arena.

So we turn, as we often do, to David Wessel, deputy Washington bureau chief of The Wall Street Journal. Welcome, David.

Mr. DAVID WESSEL (Deputy Washington Bureau Chief, The Wall Street Journal): Good morning.

YDSTIE: The Fed has taken more action in the past couple of week than it has in years, probably since the financial crisis of the late 1990s. So, are the Fed's actions working?

Mr. WESSEL: Well, I think the right answer is yes and no. The Fed has managed to reassure people that it's on the job. Some of the indicators of stress in the financial markets have improved. The market for jumbo mortgages, those bigger than $417,000, has improved a little bit. But this is going to take time. It's not going to be resolved in a couple of days. And these are still very tense times in the markets.

YDSTIE: A lot of people on Wall Street still want to see a cut in the federal funds rate from the Federal Reserve. Is that likely to come?

Mr. WESSEL: The markets think the Fed is almost certain to cut interest rates either at its September 18th meeting or before then. If conditions improve, however, I don't think that's baked in the cake.

The Fed is trying to treat the disease very precisely. The disease is a reluctance to lend, particularly a reluctance to lend on collateral that used to be considered good but is now suspect - mortgages of all kinds, some kinds of commercial paper and so forth. If the Fed thinks that lower rates will help keep the machine going, I think it will cut rates. But it hasn't completely lost its focus on inflation. And if it thinks that's not the right medicine, it may surprise the markets.

YDSTIE: Many Democrats, like senators Chris Dodd and Hillary Clinton, both who are running for president, have seized on the problems in the credit market to criticize the Bush administration for taking a hands-off approach. Is their criticism fair, do you think?

Mr. WESSEL: Well, I think you have to divide this in two pieces. Why did this situation arise? Who was at fault? And it's hard to absolve the government. It's hard to absolve the credit rating agencies like Moody's and Standard & Poor's. It's hard to absolve Wall Street.

People lent a lot of money on ridiculously favorable terms to people who had very little prospect of paying it back. And then they sold those loans to investors and they went sour. The investors got hurt. And in some cases, the homeowners got hurt. This reflects a very laissez faire approach to regulation on the part of the Bush administration and the Federal Reserve about the mortgage business, some difficulties in the divided responsibilities between state and Federal regulators. So, yes, people are going to go back and say what did we do wrong and how do we avoid this particular problem from happening again. Of course, that's separate from the problem about what you do about it now that it's happened.

YDSTIE: Yeah. And the Democrats are arguing that there needs to be some relief for these people who are being foreclosed on. And early, the president said he wasn't going to give any specific help to people who were having trouble paying their mortgages. Is the administration reconsidering that now?

Mr. WESSEL: I think the administration has to look at what's going on in the mortgage market, see the number of people affected and the risk to the economy, and say there must be something we can do. And I think they're actually thinking about what they can do. One of the most likely options, I believe, is to do things to help people whose mortgages have not yet gone on to foreclosure, but who are at risk of foreclosure because the rates on their mortgages are going to go up a lot in the next couple of years. They may, for instance, use the Federal Housing Administration, a New Deal-era agency that's embedded in Department of Housing and Urban Development, to help people who have such mortgages get different mortgages so that they can keep making payments.

YDSTIE: David Wessel, deputy Washington bureau chief of The Wall Street Journal. Thanks very much.

Mr. WESSEL: You're welcome.

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