CIAO DATE: 07/2008
January 2008
American Enterprise Institute for Public Policy Research
I see nothing in the
present situation that is either menacing or warrants pessimism. . . .
I have every confidence that there will be a revival of activity in the
spring and that during the coming year this country could make steady
progress.
--Andrew W. Mellon, U.S. Secretary of the Treasury, December 31, 1929
The bursting of every bubble is followed by statements suggesting that the worst is over and that the real economy will be unharmed. The weeks since mid-March have been such a period in the United States. The underlying problem--a bust in the residential real-estate market--has, however, grown worse, with peak-to-trough estimates of the drop in home prices having gone from 20 to 30 percent in the span of just two months. Meanwhile, the attendant damage to the housing sector and to the balance sheets tied to it has grown worse and spread beyond the subprime subsector.
Of the 130 million U.S. housing units, 18.5 million--almost 15 percent--are empty. This bodes ill for the outlook for homebuilding; house prices; and the balance sheets of commercial banks, investment banks, and American households. In June, Congress will pass the Foreclosure Prevention Act of 2008. This is a symbolic measure that will not become effective until October 1 and, given its cumbersome structure, will provide virtually no relief to the households facing foreclosure that it is designed to help.
At the same time that U.S. house prices are continuing to collapse, the Federal Reserve's interest-rate cuts to cushion the U.S. credit crisis, coupled with a continued surge of funds into emerging-market nations and a stubborn refusal by those nations to allow their currencies to appreciate and to stop holding domestic energy prices at far below market levels, have pushed the price of oil up by nearly 30 percent since mid-March alone. The rise is sufficient by itself to absorb virtually all of the $115 billion in rebate checks being distributed to Americans in the second quarter. If the jump in food and energy prices leaks into core U.S. inflation (which thankfully has not yet happened), then, as Federal Reserve vice chairman Donald Kohn said with classic understatement on May 20, "We would be facing a more serious situation" concerning inflation. Needless to say, with shaky financial markets and a shaky real economy, the need for the Federal Reserve to respond to an elevated threat of inflation would constitute a "serious situation" indeed.
Resource link: False Dawn [PDF] - 98K