> On Dec 11, 2007, at 8:44 PM, Bob Morris wrote:
>
>> I also think they are seriously worried about what's coming.
>
> If they are, they're disguising it well.
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So far the Fed hasn't seen banks failing to meet their reserve capital
requirements, or non-financial corps unable to raise funds, or any
extraordinary increases in interest rates, corporate bankruptcies, or
unemployment. Financial sector profits and share prices are taking a
beating, though not all financial institutions are as exposed as Citibank,
UBS, or Merrill Lynch. The stronger banks, vulture funds, and sovereign
wealth funds have already shown they are prepared to buy in when they think
the price is right. Most are waiting for the banks to bottom out only when
their junk holdings of MBS's are marked down even further in the wake of an
expected wave of ARM resets and foreclosures next year.
My sense is the Fed and other central banks are much more worried about a run on the dollar than they are about an American recession, even one which takes down some of the more vulnerable US banks and mortgage lenders. Hence their slow and measured movement on rates, which is likely to change only if this crisis threatens to become deeper than previous ones they have had to face. So far, while worried and watchful, they appear to be are no more "seriously worried" than that.
This excerpt from a front page Wall Street Journal article earlier this week ("U.S. Mortgage Crisis Rivals S&L Meltdown", December 10, 2007, p.1) is probably a pretty good reflection of Fed thinking, including Volcker's caution at the end:
"So far, the potential losses look manageable compared with the savings-and-loan crisis of the 1980s and the tech-stock crash of 2000-02. But the housing debacle could yet take years to work out, thanks to the sheer complexity of it. Until the mess is cleaned up, investors will remain jittery and banks will likely hold back on all kinds of lending -- a credit crunch that is already damping global growth and could tip the U.S. economy into recession.
"House prices are down by 0.5% to 10% now, depending on the measure used. If they fell 30% -- what it would take to restore their historic relationship to inflation, rents and incomes -- $6 trillion worth of housing wealth would be wiped out. Measured against the size of the U.S. economy, that is less than what was lost in the stock market between 2000 and 2002. Initial guesses at total losses on subprime and similar mortgages range from $150 billion to $400 billion.
"The latter figure would equal about 3% of U.S. annual economic output. That is similar to the losses suffered by S&Ls and commercial banks between 1986 and 1995. But it is less than half the scale of Japanese bank losses in the wake of that country's burst stock and real-estate bubbles.
"Banks are far less exposed to serious damage than during the 1980s. Nonetheless, the shift of loans from banks to markets has created a staggering complexity that threatens to prolong the crisis.
"In spite of the gloom, the economy may avoid recession. Housing comprises a much smaller share of the economy than business investment, which dragged the U.S. into recession in 2001. Also, the rest of the world is stronger than in 2001, boosting U.S. exports. For the entire U.S. economy to contract would probably require a broad decline in consumer spending, which hasn't happened since 1991.
"And, while financial problems are serious, they aren't -- at least yet -- on a par with those of the 1980s, when many major banks would have been insolvent had they valued their Third World loans accurately. There is, indeed, a possibility that the opacity of today's mortgage securities means markets may be factoring in far larger losses than will actually occur. Though the Fed is still worried about inflation, it has plenty of room to cushion the economy with additional interest-rate cuts.
"But after years of living off the debt-financed increases in the value of their homes, U.S. consumers are in uncharted territory. "A lot of people, including me, have been saying that the country has been spending more than it's been producing, and that will have to come to an end," says Mr. Volcker. "The question is: Does it come to an end with a bang or whimper?"