Kash and Nouriel Roubini are worried that the bad loans in the subprime market may spillover onto the rest of the economy via a credit crunch. AB reader OldVet points us towards Jephraim Gundzik who is concerned with increasing perceptions of risk:
Plunging stock markets around the world and dollar depreciation indicate that risk perceptions are changing dramatically. This change in risk perception will produce a prolonged and sharp correction in all of the world’s stock markets. Growing risk aversion will push US Treasury yields lower, triggering dollar devaluation and soaring precious-metals prices in the months ahead.
Gundzik argues that the expansionary monetary policies of the Federal Reserve and the Bank of Japan “masked rising global investment risk”. He also argues:
The Fed reversed course in late 2004, but the very slow pace of monetary-policy tightening did little to weaken thriving mortgage-credit growth, which continued to bound higher in 2005. The combination of super-loose monetary policy and very gradual monetary-policy tightening encouraged mortgage lenders in the US greatly to loosen credit standards, triggering unprecedented growth in US real-estate values and home construction. The booming housing market accelerated US economic growth, further obscuring investment risk associated with very rapid credit growth and sharply deteriorating credit standards … Though monetary policy in the US and Japan remains extremely loose, the sudden downdraft in global equity markets and dollar depreciation, which began early this month, indicate that risk perceptions have changed dramatically. This sudden shift was driven by unexpected weakness in the US economy – the product of the collapsing housing market, soaring real-estate foreclosures, and their very negative impact on the US financial system.
If we are about to see an investment slump – I trust these folks are not saying we need to return to tight monetary policy. Actually, I tend to agree with Gundzik as he writes:
Though interest rates will fall in the US, this will not immediately stimulate a resurgence in the housing market. Mortgage lenders and banks saddled with growing non-performing loan portfolios will continue to tighten credit standards, leaving many potential borrowers in the cold. At the same time, surging foreclosures will add to the housing supply, forcing home prices much lower. This loss of home equity combined with a credit drought will undercut private demand in the US, prompting a rise in unemployment and further weakness in private demand.
He also sounds pessimistic about world business investment demand. The Chairman of the Federal Reserve does not appear to share this pessimism. I hope Ben Bernanke is correct, but I don’t envy his job over the next several months.