The rate setting Federal Open Market Committee (FOMC) of the US Federal Reserve is expected to cut the key federal funds rate on Tuesday. Meanwhile, the Former Fed Chairman said in an interview that the level of US house price falls could be in in double-digits.
Wall Street professionals have been clamouring for an aggressive interest rate stance to keep the markets in clover. Most of the same people firmly dismissed any risk of "contagion" from the subprime crisis, which first hit the news last February when global bank HSBC announced a $2 billion hike in its loss provisions, having been burnt by lending to individuals who had the riskiest credit records in the market.
While the US stock market rose last week on optimism that a widely expected interest-rate cut by the Fed would boost stocks, apart from psychology, a rate cut would provide no short-term solution for the deteriorating housing housing market recently joined by high gasoline prices, that are likely to dampen consumer spending.
It is expected that the US economy will remain in a mode of low economic growth well into 2008.
Market watchers expect the Fed to cut the benchmark rate by 0.25% to 5.00%, rather than emulate the steeper cut moves of former Fed Chairman Alan Greenspan.
Tuesday's cut will be the first reduction after 17 consecutive quarter-point increases that took rates from an exceptionally low 1% in June 2004 to 5.25% in June 2006, where they have remained since.
Analysts hope that a cut with hints of additional moves will power the markets to a surge such as happened after the Fed rate cuts during the 1998 credit crisis. However, others caution that the combination of an Asian economic crisis, a Russian debt default and the related near collapse of a huge US hedge fund, Long Term Capital Management, cannot be compared with the brittle domestic economy today.
Greenspan expects steep fall in US house prices
US house prices are likely to fall significantly from their present levels, Alan Greenspan has told the Financial Times, admitting that there was a bubble in the US housing market.
In an interview ahead of the release today of his widely-anticipated memoirs The Age of Turbulence: Adventures in a New World, the former Federal Reserve chief said the decline in house prices “is going to be larger than most people expect”.
However, Greenspan said that his successors at the Fed, would have to be careful not to ease rates too aggressively, because the risk of an “inflationary resurgence” was greater now than when he was Fed chief.
Greenspan said he would expect “as a minimum, large single-digit” percentage falls in US house prices from peak to trough and added that he would not be surprised if the fall was “in double digits”.
Greenspan told the FT that house prices were probably already down about 2-3 per cent from their peak on a national level.
However, he cautioned that it was very difficult to predict how large the ultimate decline would be.
Greenspan said that the current turmoil in financial markets was “an accident waiting to happen”.
In an interview broadcast Sunday, Greenspan told the CBS 60 Minutes programme that he "didn't really get it" that the sub-prime lending trend was significant enough to hurt the economy until very late 2005, but still defends his lowering of interest rates from 2001 until 2004 that critics say caused the crisis in the first place.
He said in his FT interview, that the price of risk had fallen to unsustainably low levels beforehand, with investors addicted to asset-backed securities that offered some additional yield over Treasury bonds as if they were “cocaine”. Greenspan said this demand induced the big increase in the origination of subprime mortgages by mortgage brokers.
The rise in defaults on subprime mortgages was only the trigger that set off a broad re-evaluation of risk, he argued.
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