Housing Turmoil 'Threatens US Economy'

Source : The Straits Times, Sep 12, 2007

Fed officials say there is a risk of broader downturn; comments set stage for rate cut

WASHINGTON - TWO senior Federal Reserve officials said on Monday that the turmoil in housing and mortgage lending has begun to threaten the overall US economy.

Their statements set the stage for a likely cut in the Fed's benchmark interest rate next week.

Fed governor Frederic Mishkin told a group of investors on Monday that the risk of a broader downturn 'cannot, in my view, be ruled out'.

Mr Mishkin said inflation pressures had become less of a problem - a judgment that, if embraced by other Fed officials, would remove a major argument against lowering interest rates.

Fed Bank of San Francisco president Janet Yellen said a housing downturn and tighter credit were likely to cause 'significant downward pressure' on consumer spending and, thus, on economic growth.

Even if investors overcome some of their fears, mortgage rates are likely to remain higher on a long-term basis and could continue to push housing prices down, she said.

'Should the decline in house prices occur in the context of rising unemployment, the risks could be significant,' she added.

Her comments highlighted a point recently stressed by Fed chief Ben Bernanke, that officials do not plan to wait for irrefutable statistical evidence of an economic downturn.

Rather, they are ready to act on warning signs, including anecdotal business reports, that the probabilities of a downturn are too high to ignore.

In response to the comments, Fed watchers said it seems likely that an interest rate cut will take place.

However, they said it is not clear if Mr Bernanke and his colleagues are ready to cut as much as investors expect, and many economists say they must, to keep the United States out of a recession.

The contrasting remarks made by two other Fed officials indicated that there may be some divide among the policymakers themselves as to what to do next week.

Dallas Fed president Richard Fisher said on Monday that the bleak jobs report was merely a 'discordant note', and that he was still unpersuaded about a broader downturn.

Philadelphia Fed president Charles Plosser said earlier last Saturday that policymakers should not put too much stress on the loss of jobs last month, and that he had not made up his mind yet on a rate cut.

The scope of remarks may reflect a debate inside the US central bank over whether to lower the benchmark rate on Tuesday by a quarter-percentage point, or a half-point, as some investors expect.

Meanwhile, market conditions have turned investors jittery.

On Monday, European Central Bank president Jean-Claude Trichet warned of 'hectic behaviour' in the global economy and urged central bankers to keep a close eye on the US for signs of an economic slowdown.

'This is no time for complacency. The current situation calls for close observation and monitoring,' said Mr Trichet at a gathering in Basel, Switzerland, of the world's top central bankers, including US Federal Reserve chairman Ben Bernanke and the Bank of Japan governor Toshihiko Fukui.

A survey by the US National Association for Business Economics, meanwhile, lists a recession as the greatest risk to the US economy over the next year, outpacing inflation as the biggest concern by a two-to-one margin.

The economists forecast a half-point cut in the federal funds rate by the end of the first quarter of 2008, up from May's forecast of a quarter-point cut.

NEW YORK TIMES, REUTERS, BLOOMBERG NEWS