The US Housing Market and the Subprime Mortgage Crisis (B): Impact on the US Economy

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“The Federal Reserve is not currently forecasting a recession.”¹

- Ben Bernanke, Chairman of the US Federal Reserve, in January 2008.

“The economy is strong, flexible and dynamic enough to weather this storm.”²

- George W. Bush, President of the United States, in December 2007.

“Housing has been providing a headwind to the economy, and there is a penalty to growth from the current situation in housing.”³

- Robert Steel, the US Treasury Under-Secretary for Domestic Finance, in October 2007.

Introduction

On March 19, 2008, the United States Federal Reserve4 cut the interest rate (the Federal Funds rate)5 by 75 basis points,6 from 3 percent to 2.25 percent. The US Federal Reserve said in a statement, “Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened.”7 Earlier on January 30, 2008, the Federal Funds rate had been reduced from 3.5 percent to 3 percent. The interest rate cuts were prompted by fears of an economic recession.

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1] “Fed Boss Says 2008 Outlook Worse,” http://news.bbc.co.uk, January 11, 2008.

2] “Bush Details Housing Rescue Plan,” http://news.bbc.co.uk, December 6, 2007.

3] Steve Schifferes, “Credit Woes ‘Need Private Action',” http://news.bbc.co.uk, October 26, 2007.

4] The United States Federal Reserve came into existence in 1913 when President Woodrow Wilson signed the Federal Reserve Act into law. The Federal Reserve serves as the central bank of the US. It supervises and regulates the banking institutions in the country, provides financial services to the US government, depository institutions, and foreign official institutions, and manages the nation's money supply through monetary policy.

5] In the US, banks are required to keep a certain percentage (generally 10 percent) of their demand deposits with the US Federal Reserve. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions. The federal funds rate is determined by supply-demand considerations; the Federal Reserve sets a target for the funds rate, and seeks to control it by injecting or draining funds from the market through its Trading Desk at the Federal Reserve Bank of New York. (Source: www.federalreserve.gov)

6] Basis point is one hundredth of a percentage point (0.01 percent).

7] “US Federal Reserve Slashes Interest Rates to Shore up US Economy,” www.hindustantimes.com, March 19, 2008.

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