updated 5/18/2006 3:39:27 PM ET 2006-05-18T19:39:27

The housing market, after flying high for five years, has lost altitude and appears headed for a safe landing, Federal Reserve Chairman Ben Bernanke said Thursday.

Major Market Indices

“It seems pretty clear now that the U.S. housing market is cooling,” Bernanke said in a question-and-answer session following a speech he delivered on banking in Chicago.

He noted that home sales are slowing as is housing construction.

“Our assessment at this point ... is that this looks to be a very orderly and moderate kind of cooling,” Bernanke said.

One of the things that Bernanke and his Fed colleagues are keeping close tabs on is the extent to which a housing cool down will slow overall economic activity.

The housing market has been a top economic performer. The sector has racked up record-high sales five years in a row. Rapid appreciation in house prices has made homeowners feel wealthy and has powered consumer spending, helping the economy move solidly ahead.

Cooling of the housing sector is expected to be a factor in slower economic growth in the months ahead.

The economy in the first three months of this year grew at a brisk 4.8 percent pace, the fastest in 2½ years. Many economists predict growth will moderate to around 3 percent in the April-to-June quarter, still a good pace.

Bernanke did not discuss the future course of interest rates in his speech or in his remarks afterward.

The Fed, which boosted rates last week, left its options wide open in terms of future rate decisions. It suggested that another rate increase could be possible if inflation worsens, or a pause in its two-year-old rate-raising campaign could be in store if economic growth slows.

Some economists believe the odds are growing that the Fed will bump up rates again at its next meeting, June 28-29. Those analysts said the odds went up after a government report Wednesday showed that consumer inflation bolted ahead in April.

Others, however, believe the Fed will pause in June on the grounds that economic growth will slow and ease inflation pressures.

On the issue of risky home mortgages, Bernanke pointed out that the Fed has issued some guidance for lenders and he underscored the importance of borrowers making sure they understand how interest-only and other nontraditional mortgages work.

“We’re not saying you shouldn’t make these loans. What we’re saying is that they be done the right way,” Bernanke told the banking conference.

Borrowers and lenders holding exotic mortgages could get clobbered if housing prices drop or interest rates rise sharply.

In his speech, Bernanke said federal banking regulators will press ahead on a sweeping plan aimed at improving risk management for the country’s largest and most internationally active banks.

The proposal, years in the making, dubbed Basel II, would instruct such banks to use complex new risk formulas to determine capital requirements.

The thrust of the proposal is to promote stability of the U.S. financial system and make big banks better able to withstand any financial problems that might erupt in the global marketplace.

“No immediate crisis requires us to move toward Basel II, but the gradual evolution of market practice and the emergence of very large and increasingly complex banking organizations operating on a global scale require that we make significant changes in the way we assess capital adequacy at these organizations,” Bernanke said at a banking conference organized by the Federal Reserve Bank of Chicago.

“Indeed, waiting for a crisis to force change would be foolish; by moving forward now, we have the luxury of being deliberate in the development and introduction of a system that promises significant benefits,” Bernanke added.

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