LyrArc Article Gist
How Martin Feldstein weighs the risks of inflation and of moral hazards in helping those who fueled the subprime crisis with their mistakes with the risks of a sharp downturn, and what thoughts he has on the issue of lowering rates just as the Bernbanke Fed prepares for its policy meeting September 18, 2007. He looks for a cut starting from the current 5.25% to 4.25% or even less depending on the situation as it evolves. Feldstein gives a measure for household wealth that will be lost and what will be lost in consumer spending as a result. His measure is for a 20% cumulative fall in house prices that would reduce household wealth by $4 trillion which would impact consumer spending by about $200 billion, thats about 5% consumers would spend more if they had that $4 trillion. This works out to about 1.5% of GDP which he suggests would tip the US economy into a recession. This is not counting the loss of access to spendable cash that the consumer has used for the last decade in terms of mortgage equity withdrawals which totaled $9 trillion this last decade and financed a lot of the sustained consumer spending, these mortgage equity withdrawals to finance spending would decline significantly in the new conditions. In addition with more defaults and falling prices in a vicious circle the process could accelerate quickly, further impairing the portfolios of banks and financial institutions causing some to collapse.