Sunday, December 30, 2007

Shiller: Fed to Cut Rates Below 3 Percent

Courtesy of MoneyNews.com

The housing crisis will likely continue for another five years before hitting bottom.

As a result, the Federal Reserve will cut rates regularly this year, predicts Yale economics professor Robert Shiller.

Shiller, who was spot-on in forecasting the bursting of bubbles in the stock market in 2000 and then the housing market this year, sees the Fed slicing the federal funds rate below 3 percent from 4.25 percent currently.

"We’re continuing to see a weakening of the housing market,” Shiller says in an interview with Bloomberg News.

"What’s new is the record territory for the rate of decline. It’s faster than the worst part of the last cycle in the early 1990s.”

As for the housing crunch’s impact on the economy, Shiller foresees a softening, but not a meltdown. "Despite the disaster in the housing market and high oil prices, people are still spending.”

Personal spending soared 1.1 percent in November, the biggest rise in more than two years.

Still, Shiller thinks the housing crunch will drag the economy down enough to make the Fed cut the fed funds rate on overnight interbank loans to less than 3 percent next year. This year, the Fed lowered the rate one percentage point to 4.25 percent.

"I’m at odds with the fed funds rate futures market and most people, but I see a sequence of rates cuts in 2008,” Shiller says.

The S&P/Case-Shiller index for October showed the average price of homes in 20 major metropolitan markets plunged 6.1 percent in from a year earlier, the biggest drop since the index began in 2001.

"That momentum will continue in 2008, because in the real estate market, historically you see accelerations in the rate of decline,” Shiller says.

"That’s different from the stock market, which is largely a random walk.”

What we’re now witnessing is the unraveling of the biggest housing boom in U.S. history, indeed in the history of the entire world, Shiller says. From March 1997 to February 2007, home prices in the 20 metro markets jumped at an annual rate of 10.93 percent.

"The psychology finally unraveled,” Shiller says. "But it’s not just psychology. There was a lot of construction. Now there’s a huge inventory of unsold homes. It’s hard to see how market will pick up with this overhang.”

The amount of homes up for sale in October represented an 8.5-month supply, up a whopping 20 percent from 7.1 months a year earlier.

"I don’t expect any sudden change in the trend, because we’re not talking about professional Wall Street investors,” Shiller says.

"Most of us don’t make decisions fast, so the market doesn’t turn on a dime. Prices might not bottom out for another five years.”

The five-year forecast makes him an outlier, Shiller acknowledges. "The Chicago futures market predicts an increase for housing prices starting in 2009.”

"That’s typical of what others think. But I’m a historian and don’t see any reason for a bottom in 2009.”

The current credit market crisis represents a natural outgrowth of the housing bubble’s burst, Shiller says.

"Loans were made very freely in the early 2000s. Now with prices falling, people are starting to default, so we’re getting a seizing up of credit markets.”

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