A CRISIS OR MERE RECESSION?
March 31, 2008
While the U.S. economy is beset with serious difficulties, there are equilibrating forces in play which suggest that this could end up as a recession but not a crisis, says writer Ajay Shah, a senior fellow with the National Institute for Public Finance and Policy, New Delhi.
This is undoubtedly a difficult situation. But is it a crisis?
- One estimate of the size of losses on sub-prime home loans is $400 billion.
- This is roughly 2.85 percent of U.S. gross domestic product (GDP).
In the idealized world of securitization, a parcel of home loans is converted into securities, which are then sold into the broad market. The ownership of these securities is dispersed amidst international hedge funds, pension funds, etc. Securitization has given a substantial dispersion of the $400 billion loss. For this reason, the impact of the massive loss on the U.S. financial system is not as large as it might otherwise have been.
The second equilibrating channel lies in monetary policy, says Shah:
- Unlike many other countries which have experienced crises, the United States has well functioning institutions for conducting monetary policy.
- The U.S. Fed has cut rates dramatically in response to difficulties in the economy; on 14th March, the 90-day treasury rate in the United States had dropped to 1.16 percent.
- Certain impact is surely there; low interest rates are helping strengthen demand and help attract smart speculators to buy assets at fire sale prices.
Low interest rates are doing their job in one critical respect: the decline of the dollar. When interest rates dropped, the dollar fell -- exactly as it should. The weak dollar is bolstering net exports and helping the economy, says Shah.
Source: Ajay Shah "A Crisis? Or A Mere Recession?" Business Standard, March 19, 2008
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