The housing slump is expected to stymie U.S. economic growth through early 2008, Federal Reserve Chairman Ben S. Bernanke said during a speech Monday at the Economic Club of New York.
“A further sharp contraction in residential construction seemed likely to hold down overall economic growth in the fourth quarter and in early 2008,” Bernanke said, noting that data since the Federal Open Market Committee’s latest meeting on Sept. 18 suggest “further weakening in the housing market, as sales have fallen further and new residential construction has continued to decline rapidly.”
While the housing market “is likely to be a significant drag on growth” over the next several months, Bernanke added, “it remains too early to assess the extent to which household and business spending will be affected by the weakness in housing and the tightening in credit conditions.”
While the Fed suggested in a July report to Congress that the weakness in the housing market might pull down consumer spending, “direct evidence of such spillovers onto the broader economy has been limited,” Bernanke said.
In response to tightening credit conditions, the committee cut its target for the federal funds rate by 50 basis points, and Bernanke noted in his speech that “committee members judged the level of uncertainty in the outlook to be unusually high” because of inflation risks, elevated oil prices and other factors.
The September reduction in the federal funds rate, to 4.75 percent, was the first rate cut since June 2003. The Fed had raised the rate 17 straight times from June 2004 to June 2006.
The decline in the housing sector, which began in the second half of 2005, “has intensified this year as demand has declined further, inventories of unsold new homes have climbed relative to sales, and house prices have decelerated, with some areas of the country experiencing outright declines in home values,” Bernanke said, adding that home builders have cut back sharply on new construction.
The rate of serious delinquencies for subprime mortgages with adjustable rates has “risen notably,” Bernanke also said, reaching about 16 percent in August, which is about three times as high as it was in mid-2005.
“Subprime mortgages originated in late 2005 and 2006 have performed especially poorly, in part because of a deterioration in underwriting standards. Moreover, many recent-vintage subprime loans will experience their first interest-rate resets in coming quarters. With the softness in house prices likely to make refinancing more difficult, delinquencies on these mortgages are expected to rise further.”
Few securities backed by subprime mortgages have been issued since July, he also noted, as investors have become increasingly wary about the credit quality of subprime and other mortgages and questioned the reliability of credit ratings on mortgages that are bundled as structured credit products, for example.
Subprime problems “were perhaps more a trigger than a fundamental cause of the financial turmoil,” Bernanke said, as that market led investors to question valuations and reduce their appetite for a range of credit products, “not just those backed by subprime mortgages.”
Problems in the subprime mortgage market have mushroomed into problems for lower-risk alt-A and jumbo mortgage loans, and the “continued problems suggest that investors will need more time to gather information and reevaluate risks before they are willing to reenter these markets,” Bernanke said.
Bernanke outlined several steps the Fed has taken steps to enhance liquidity, and said that these steps have “served to reduce some of the pressure in financial markets, although considerable strains remain.”
“Conditions in financial markets have shown some improvement since the worst of the storm in mid-August, but a full recovery of market functioning is likely to take time, and we may well see some setbacks,” he said. “The ultimate implications of financial developments for the cost and availability of credit, and thus for the broader economy, remain uncertain.”