US Federal Reserve Chairman Ben Bernanke has reminded investors around the world that the US economy is facing a prolonged period of sub par performance. In a speech in New York he said that the US housing slump will be a "significant drag" on U.S. growth into next year, though he added that evidence of a broader impact on spending was limited.
Economists said these and other comments in the speech, plus the solid jobs and retail sales figures, have ruled out another cut in US interest rates when the Fed meets for two days at the end of the month.
"The Federal Reserve will continue to watch the situation closely and will act as needed to support efficient market functioning and to foster sustainable economic growth and price stability," Bernanke said in a speech to the Economic Club of New York.
He said that credit markets have improved, while a full recovery will take time "and we may well see some setbacks."
Bernanke's speech was the first on the economy since August and it came as investors have trimmed their expectations of another rate cut this month. Retail sales rose last September and jobs and wages have picked up, suggesting consumers are not being that battered by the subprime mess and the worst housing slump since 1991. But housing sales and starts are not going to get any better for a while and that seemed to be the tenor of the chairman's commentary.
As Fed Vice Chairman Donald Kohn did two weeks ago, Mr Bernanke pointed out risks to both growth and inflation, declining to steer investors on whether he favors lower borrowing costs. The Fed's Open Market Committee lowered its benchmark rate by a half point to 4.75% on September 18, the first cut in four years, to protect the US from sinking into a recession sparked by fallout from the housing-market collapse. What it did was spark a rally in stock markets, a surge in commodity prices and a fall in the value of the US dollar. That in turn has driven the likes of copper and gold higher, while renewed middle east tensions have driven world oil prices past $US86 a barrel and climbed to within sight of $US88 a barrel.
"The ultimate implications of financial developments for the cost and availability of credit, and thus for the broader economy, remain uncertain," Bernanke said in his speech and in commentary afterwards "It remains too early to assess the extent to which household and business spending will be affected" by the housing recession.
"This current financial stress is not likely to disappear overnight; partly it is an information problem," Bernanke said in answer to a question. "It is going to take a while for investors to appropriately value these assets." And he also echoed the comments of Reserve Bank Governor Glenn Stevens on the need for more openness and information on the credit derivatives and other securities that have caused the problems: "I would like to know what those damn things are worth," Bernanke said, referring to the products that investors have shunned in the credit rout.
"This episode has revealed a weakness in structured credit products," namely the difficulty in coming up with valuations in periods of stress.
The pressures of the subprime mess were confirmed when Citigroup reported a 57% drop in third quarter earnings (and put itself on quite a few watch lists for senior management changes as a result) because of the $US5.9 billion in losses and write-downs revealed a week earlier as a result of the subprime mess and the credit freeze's impact on leveraged buyouts. Three other banks, including Well Fargo, America's second biggest mortgage lender, reported lower third quarter earnings because of rising losses and provsions for dud housing and other loans.
Nomura, the big Japanese broker also revealed plans to quit the US subprime
business and cutback its American operations by up to 30%. Nomura also
revealed hundreds of millions of dollars in losses. And with the 2008 US
Presidential and Congressional election campaign well underway, China has
thrown a major issue into the mix with the news that a big Chinese bank
wants to buy a stake (up to 20%) of the Wall Street investment bank, Bear
Stearns. Bear Stearns is the bank that triggered much of the credit freeze
when two of its hedge funds collapsed, with losses of over $US1.6 billion
due to dud investments in subprime mortgages and associated credit derivatives.
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