MARGARET WARNER: Last night’s comments by Federal Reserve Chairman Ben Bernanke marked the second time this week Fed officials had hinted at a possible interest rate cut to steady the economy. He spoke during a week of troubling economic data and stock market volatility.
There was more bad news on the housing front: In October, the median price of a new home fell 13 percent from a year ago, to $213,000; and construction activity slumped by a greater than expected amount.
On economic growth, it was a mixed picture. The nation’s third-quarter GDP was reported at a stronger than expected 4.9 percent. But on Thursday, the Bush administration lowered its forecast for economic growth next year, to 2.7 percent from the earlier 3.1 percent.
All of that conflicting data, and the remarks by Fed officials, led to a wild ride on Wall Street this week. On Monday, the Dow Jones dropped more than 200 points, down 10 percent from its October high. But Tuesday and Wednesday, the index posted its biggest two-day rally in five years, up more than 500 points.
To make some sense of it all, we turn to two business writers, David Wessel, economics editor of the Wall Street Journal; and Saskia Scholtes, capital markets reporter for the Financial Times.
Welcome to you both.
So, David, beginning with you, make sense of this for us. I mean, why all this gyrating data from housing, to oil prices, which are actually a little better, to the economic growth projections and the market? What does it all add up to?
DAVID WESSEL, Wall Street Journal: Well, it adds up to a lot of uncertainty and confusion, as your report suggested. You know, former Federal Reserve Chairman Alan Greenspan used to say almost any time he was asked that we were living in a period of great uncertainty. I think this is actually a moment for which those words were designed.
We have, as you pointed out, a week where we thought we were going to hit $100 a barrel in oil. Now oil is below $90. We had a week that began with people expecting the Federal Reserve to hold the line on interest rates, but after Vice Chairman Don Kohn and then Chairman Ben Bernanke spoke, now the markets expect a cut in interest rates.
And we see the housing problem continue to get worse and the side effects, the freeze-up in credit markets, the reluctance of lenders and big banks to lend even to each other intensified, so I think that’s put a very dark cloud over the economic horizon.
MARGARET WARNER: So then, Saskia, why do we have the markets reacting as they did, which is they’re up for the week 3 percent?
SASKIA SCHOLTES, Financial Times: Well, investors have been particularly bipolar in recent months, as the credit crisis has played itself out in the credit markets. Stock market investors have been struggling to make sense of the economic data that they’re seeing.
Now, this week we had some very, very poor housing data, but to a degree investors have become accustomed to seeing very poor housing data, so they were trying to make sense of comments from Federal Reserve Chairman Ben Bernanke and his vice chairman, Donald Kohn, which hinted that an interest rate cut was on the way, which helped stock markets rally.
They also saw some bright spots in oil prices that were easing and some stability in the U.S. dollar, which showed that the Federal Reserve will have room to cut interest rates if they really need to, to tackle problems in the economy.
Abu Dhabi provides capital
MARGARET WARNER: And then, David, also we had Abu Dhabi stepping up to help -- can I use the phrase -- bail out Citigroup?
DAVID WESSEL: I'm sure they wouldn't use that phrase. Right, one of the side...
MARGARET WARNER: An "infusion of capital" I guess is what you call it.
DAVID WESSEL: Citigroup sold 5 percent of itself to the Abu Dhabi Investment Authority for $7.5 billion on terms that seemed very favorable to the Abu Dhabi fund.
What's going on here is that the nation's commercial banks, which we believed were these great pillars of stability and strength when we began this crisis, turn out to have eroded a lot of their capital because they've had to take big losses on some of these subprime and other mortgage-backed securities.
Citigroup's capital, that cushion that a bank uses to protect itself when times get bad, was running down. Citigroup was looking for a very quick way to restore its capital, and they turned to Abu Dhabi. A Saudi investor already has a very large stake in Citigroup, as well. And I suspect other financial houses will be looking for capital, as well.
Freddie Mac, the big mortgage giant, did another route. They sold an issue of preferred stock. And this has, I think, cheered the markets, because it gave people some sense that maybe there's a light at the end of this very long tunnel.
MARGARET WARNER: Saskia, do you agree, that the markets saw this as a good sign, not a troubling sign?
SASKIA SCHOLTES: Well, stock markets saw it as a good sign that the capital was there if companies like Citigroup and Freddie Mac -- and there was also a bond insurer, CIFG, that was bailed out by two French banks a couple of weeks ago. So the stock markets took it as a good sign that the capital is there if they need it.
But it was interesting to see how the bond markets reacted. They were very, very concerned that it means there are problems out there that we, perhaps, haven't yet seen come to light.
Subprime ripples still being felt
MARGARET WARNER: So, David, that is really the question, is it not? That is, one, is this still being driven -- really, is this all fallout from the subprime mortgage and resulting credit crunch? And, two, does anyone have any idea if we've seen the worst of it or there are still huge losses to be reported?
DAVID WESSEL: Well, it is definitely the fallout of the subprime mess creating a credit crunch which has spread all around the world. There's big problems in Europe, as well, compounded by all the other things that have been going on, including oil.
I don't know that anybody can accurately say we've seen the bottom of this. When you see a bottom is when prices have fallen so far that these real shrewd investors, the Warren Buffetts of the world, come in and say, "It's such a low price, I'm going to buy it. It's a bargain."
And we haven't had that big jolt of confidence just yet. And I think that's one of the things that's causing great concern at the Federal Reserve and elsewhere.
MARGARET WARNER: So, Saskia, given that situation, then how much will an interest rate cut -- if, in fact, it happens at the next Fed meeting in two weeks -- what will that do? I mean, how much can an interest rate cut really help, if nobody knows how far we still have left to fall just in the mortgage crunch?
SASKIA SCHOLTES: Well, there is hope that an interest rate cut would mean that credit becomes more readily available to borrowers and more readily available at the financial markets level.
But the problem is that an interest rate cut is actually quite a blunt tool to solve the kinds of problems that the economy is facing right now, and that's because it not an economic problem right now. It's a financial markets problem.
And an interest rate cut doesn't solve that. It doesn't make banks willing to lend to one another, because what's stopping banks lending to one another is a lack of information about what's on people's balance sheets and what is the counterparty risk when you lend to another bank.
MARGARET WARNER: And why is there still that lack of information, Saskia?
SASKIA SCHOLTES: Well, there's been a huge amount of write-downs so far, but there's been very little clarity as to exactly how those write-downs have been calculated and whether they'd been calculated in a consistent manner from bank to bank.
So Merrill Lynch, for example, came out with an initial estimate of its write-down which it later had to revise dramatically upward to $7.5 billion, I think it was, a few weeks ago, resulting in the ouster of its chief executive. And that's been a similar picture right the way across Wall Street.
Now, with that level of uncertainty, you can imagine that one bank may worry that if they lend to another bank overnight they may have a nasty surprise when they come back into work in the morning.
Treasury still weighing options
MARGARET WARNER: And then, David, the Wall Street Journal, your paper, reported on another sort of palliative action that's at least out there as a possibility, and that is that the Bush administration and some of these big financial institutions are nearing agreement on a plan in which the financial institutions would agree to freeze the interest rates on some of these subprime mortgages coming due. How close is such an agreement? And how much impact would it have?
DAVID WESSEL: I think you're absolutely right. What's going on is here -- there's a whole lot of problems that have already happened, and people are picking, dealing with the damage they've caused.
But there's one, big problem that hasn't hit yet: A lot of people got mortgages with interest rates. They're not really very low rates, 7 percent, 8 percent rates. And those mortgages are going to go up to much higher rates, 10 percent, 11 percent, 12 percent in the next year.
About two million people between now and 2008 will see their mortgages go up, and a lot of those people won't be able to make their payments, and they will go -- those loans will go into foreclosure unless something happens.
So what the administration -- Sheila Bair at the Federal Deposit Insurance Corporation has been very involved in this, now Treasury Secretary Paulson. What they're trying to do is find a formula, so instead of having case-by-case restructuring of these loans, where a different deal is struck that people might be able to pay to avoid foreclosure, they're trying to come up with a system that at least the best borrowers here, the ones who are current on their mortgages, can get an across-the-board deal so that we can avoid all these foreclosures.
Foreclosures are bad for the individuals; bad for their neighborhoods; and, the administration argues, bad for the people who hold these loans, because an empty house is worth less than a full house.
Impact on "ordinary Americans"
MARGARET WARNER: And, Saskia, though, meanwhile, the White House did revise downward, as we reported, their economic forecasts for all of next year from 3.1 percent to 2.7 percent. How will ordinary Americans feel that in the next six to eight months?
SASKIA SCHOLTES: Well, that's the $64,000 question, as they say. It's very difficult to gauge exactly how consumers will respond before we have a better sense of how the financial markets crisis is going to feed through to the economy. And that's exactly what the Federal Reserve is trying to figure out at the moment.
But there are three main sharks stalking the U.S. economic swimmer, if you like. It's the housing shark, the oil shark, and the credit shark. And the credit shark is probably the most worrying at the moment from a financial markets' perspective, but from an economic perspective it's the housing shark.
We simply don't know how long it will take for the housing market to correct to more normal levels.
MARGARET WARNER: And so, David, consumers potentially face still harder-to-borrow money and a falling value in your house, meaning what, consumers have to cut back their spending?
DAVID WESSEL: Well, I think we're at the cusp of seeing some real damage, I think, to consumers, even those people who are not facing foreclosure. Most economists expect that the government will report that the U.S. economy in the current quarter grew much less than 1 percent, perhaps as little as 0.3 percent or 0.5 percent. And there's a lot of talk about the odds of recession going up.
So it means -- the questions are, will this make it harder for people who are good credits to borrow on auto loans, home equity loans, and credit cards? Will people lose their jobs if we go into a recession? Will we have a kind of widespread pulling back of risk and everybody getting a little bit cautious, business and lenders all at the same time? That's a recipe for a recession.
MARGARET WARNER: All right, David Wessel, Saskia Scholtes, thank you both.
DAVID WESSEL: Pleasure.
SASKIA SCHOLTES: Thank you.