US Struggles to Avoid Subprime Mortgage Fallout
Despite expectations that the US Federal Reserve will cut interest rates next month, America’s housing slump is deepening and so are the fears of a recession.
This week some leading US economists have increased the likelihood of a recession to a 60 per cent chance.
The pain caused by the cavalier search for ever more adventurous ways to boost business and bolster annual bonuses was originally dismissed as Wall Street’s problem.
But it now looks to be spreading into the mainstream of the US economy with unemployment rising and new-home prices suffering their biggest drop in almost 40 years.
A recession in the US will hurt the global economy but most economists say the pain in Australia will be lessened by the growing strength of the Chinese and Indian economies.
August’s sub-prime mortgage meltdown can no longer be dismissed as a blip or financial wobble with vast swathes of middle America in danger of losing both their jobs and their homes.
The merchant princes of Wall Street have been forced to write-down well over $US30 billion which is bad for shareholders.
However, most worryingly the US housing market is now experiencing its worst slump in 16 years that might wipe $US1.2 trillion from house values next year, according to a report from the US Conference of Mayors.
The report has also forecast the housing market collapse will slash tax revenues by over $US6.5 billion.
After years of booming house price rises, the sobering news for homeowners is that the most recent economic data shows house values have fallen 1.9 percent in the past three months and 5 percent throughout the year.
The fall in house values is expected to have a much greater impact on consumer spending, already being squeezed by higher petrol prices, than the 2001 stock market collapse.
Despite attempts by the White House to put an upbeat spin on yesterday’s downgrading of forecast economic growth to 2.7 per cent being only a small correction, most US economists now rate the possibility of a recession next year as a 50:50 chance — up from a 30 per cent possibility a few weeks ago.
Merrill Lynch chief US economist David Rosenberg estimates the chances of a recession are as high as 60 per cent.
“Other metrics we look at suggest that the risk could be even higher,” Mr Rosenberg said.
In a speech yesterday, Federal Reserve chairman Ben Bernanke said “current stresses in financial markets make the uncertainty … even greater than usual”.
This recognition of the risks posed to the economy reinforced the market view that the Fed will cut interest rates on December 11.
The rising possibility of a rate cut boosted global stock markets this week as the sub-prime crisis continues to dominate investor thinking.
AMP Capital Investors chief economist Shane Oliver said the see-sawing that has dominated the stock market could continue for another six months.
“As we have seen over the last few months share markets are likely to suffer mood swings between worries about a US recession and the earnings outlook on the one hand and optimism on the back of on-going US interest rate cuts on the other,” Dr Oliver said.
Yesterday, Mr Bernanke also acknowledged the resurgence of financial pressures was dimming the US economic outlook.
Since the sub-prime meltdown began in August, the Fed has cut interest rates by 75 basis points to 4.5 per cent in a bid to shield the broader economy from the housing market turmoil.
But Deloitte Research director of global economics Ira Kalish said it would get worse before it got better and is predicting mortgage defaults will peak in March 2008, which might force the Fed into a number of rate cuts over the next six months.
During a visit to Melbourne this week, Mr Kalish said foreclosures would peak as the honeymoon period on the sub-prime mortgages end and higher interest rates kick-in on the huge numbers of home loans that were given out to risky debtors in 2006 and early 2007.
He expects the higher interest rates will force these low to middle class homeowners to walk away and leave banks in possession of houses that might be almost impossible to sell.
The US Conference of Mayors forecast the number of foreclosures next year stemming from mortgage defaults would increase by 1.4 million houses with a value of $316 billion. The report estimates that US GDP will fall by $166 billion in 2008 as a direct result of the sub-prime fallout and just over 500,000 less jobs will be created.
There is already a growing clamour on Wall Street for the Fed to cut rates by 50 basis points next month to counter the sharp downturn in economic indicators.
US currency markets have already fully priced in a 25 basis point rate cut to 4.25 per cent.
Next week’s employment figures are expected to be the final determinant of interest rates ahead of the Fed meeting on December 11.
But leading economists are convinced the Fed will, over the next few months, need to slash interest rates back by at least 75 basis points to 3.75 per cent to try and stave off disaster.
Westpac chief economist Bill Evans described the US economy as “fragile” and is forecasting back-to-back Fed rate cuts in December and January.
As the Fed gears up for a hectic 2008, Mr Bernanke will have his work cut out trying to shelter the mainstream US economy from the credit market turmoil.
Wall Street’s greed began the problem but it looks as if everyday mum and dads from Arizona to Wyoming might end up paying the biggest price.
US struggles to avoid sub-prime mortgage fallout
Stephen McMahon