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Bernanke and Bush on Subprime Credit Crunch

Interest-Rates / Credit Crunch Sep 05, 2007 - 08:37 AM GMT

By: David_Urban

Interest-Rates

Friday was a big day as the markets expected confirmation of a September rate cut in Bernanke's Jackson Hole speech. What they got was confirmation that the Fed is monitoring the situation and stands ready to act if the housing meltdown spills over into the general economy.

‘It is not the responsibility of the Federal Reserve –nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.' Bernanke told the markets that it is not the Federal Reserve's job to bail out speculators but they will act if there is a spillover into the general economy.


He later remarked that although recent data has been strong it may not be as relevant and more immediate data will hold greater relevance going forward. If we want to bet on a cut in September the economic data coming out between now and September 18 th will be paramount as will private conversations with business and banking contacts. The most important information will be coming from the August retail sales, August ISM manufacturing survey, August industrial production, and July personal income.

The first statistic came in on Friday with personal income rising 0.5% MoM in July and 6.6% from a year ago. Personal spending was also rising at a 0.4% MoM in July and 4.7% from a year ago. Both numbers were above market expectations.

President Bush later made a meager but correct step to suggest that Congress pass legislation to assist homeowners in obtaining FHA insurance and revising the tax code. The proposals will no doubt be topped by a Congress who will fight to fill a bill with so much pork it might affect the pork futures market.

This will not reverse the problem but in fact make it worse if it turns out to be a bailout of speculators and lenders. President Bush and Bernanke both went to great lengths to state that their jobs are not to bail out lenders and speculators. If Congress passes a bill that resembles a bailout rather than assistance Bernanke may not cut rates but rather hold them steady.

Good legislation will focus on correcting past mistakes rather than the problem currently occurring in the housing market which is deflation. Oddly enough, this is good because deflation will remove the speculators and cleanse the market. Once the fear of deflation is ended the next bull market in housing can begin.

The current tightening of mortgage standards means that people on the margin who bid up housing prices through the use of exotic mortgages and lax standards will be denied access to the type of credit which caused prices to be bid up. The buyers left in the market are now the ones who should be within that particular price range.

The drop in the number of buyers will affect sellers who will not see the same level of action for their properties. Instead of seeing homes go for values above the asking price, eventually they will cut and/or drop prices in order to make the sale. This flows back to the mortgage holders and non-sellers in the general area who will see the equity in their homes disappear through lower appraised values.

The prospect of a 15-25% deflation will not push people into foreclosure as home price deflation does not affect the monthly mortgage payment or the owners' paycheck. Both will stay the same. But housing deflation will increase the purchasing power of those looking to purchase a house as they will be able to pay less for more.

Where it does affect the owner and economy is that the home equity tap, which has for so long supported consumer spending, will now be turned off. This will not increase foreclosures by any measurable number going forward but it will slow non-essential consumer spending. If a homeowner was using home equity loans to pay their mortgage waiting to cash in on expected housing price increases then they were clearly living beyond their means. In this case, the chance for a foreclosure increases.

A final area where deflation will affect homeowners is in the sales of existing homes. If the value of homes in the area is falling then a family is more apt to stay within their current home rather than trade up the ladder using their equity as a down payment on the new home.

By David Urban

http://blog.myspace.com/global112

Communications are intended solely for informational purposes. Statements made should not be construed as an endorsement, either expressed or implied. This blog and the author is not responsible for typographic errors or other inaccuracies in the content. We believe the information contained herein to be accurate and reliable. However, errors may occasionally occur. Therefore, all information and materials are provided "AS IS" without any warranty of any kind. Past results are not indicative of future results.

PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN THE STOCK, BOND, AND DERIVATIVE MARKETS. WHEN CONSIDERING ANY TYPE OF INVESTMENT, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.

Before making any type of investment, one should consult with an investment professional to consider whether the investment is appropriate for the individuals risk profile.

David Urban Archive

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