Last Updated: 12:03am GMT 09/03/2008
Recession and fears of a crash force US central bank to bolster the credit markets again, reports Ambrose Evans-Pritchard
The Federal Reserve has again been forced to step in to alleviate extreme stress in the US credit markets, pledging $200bn (£100bn) of emergency liquidity for the banking system.
The move culminates a dramatic week that saw yield spreads on Fannie Mae and Freddie Mac agency bonds surge to the highest levels in over 20 years. A panic flight to safety across the credit universe briefly drove the yield on 2-year US Treasury notes below 1.5pc, a sign that investors may be battening down the hatches for a violent storm.
"The Bernanke circle is now deeply worried about a systemic crisis, fearing that
the "financial accelerator" may have set off a downward spiral that could prove
hard to stop.
The Fed is now starkly at odds with the European Central Bank,
which has held rates steady at 4pc since the credit crunch hit in August.
officials say privately that they are shocked by the ECB's complacency given
that Italy is falling into recession, while Spain and Ireland face property
The transatlantic rift is eerily similar to the disputes leading up
to the Black Monday stock market crash in October 1987. Traders say the discord
has begun to infect market confidence:
I have been warning for a week that a time bomb is about to explode and it could happen very soon. The quote above is a major problem. We are cutting rates as Europe is holding rates to fight inflation(which is their mandate). As a result our dollar is getting pummeled and hitting all time lows. It now takes $1.54 US to equal one Euro. This disconnect is putting even more pressure on our problems because other countries aren't complying with our rate cutting.
This could blowup our economy because inflation is already getting out of control and the its going to get worse because Ben has to keep cutting in order to save the banks. Usually as our economy deflates inflation decreases because their is less demand for things like oil because people cut back on their usage. With rising demand from India and China combined with Europe not dropping rates inflation is persistent and rising. Short term its only going to get worse with more rate cuts.
So now we have a situation where housing is deflating, the economy is facing a major recession , and inflation and getting worse because of the European bank/world demand issues. This is a recipe for disaster. I really don't see Ben getting out of this one without a major blowup of the economy. The only answer is some type of collapse and reset of the whole system.
How does this translate to housing? Well there are many risks. Inflation means people spend more on necessities which means they have less income to buy a house. The FED may be forced to Raise rates after they lower them short term in order to fight inflation which will reduce the amount of money people can borrow.
Banks are losing billions and lending at a dramatically reduced rate becasue of losses and fear which will tighten lending standards and make loans very very difficult to get. This is the spiral that Ben Bernanke worries about. Oce it gets going its hard to stop and it feeds on itself.
What then happens to housing? KABOOM!