It’s the gorilla in the back of the room that John Howard, Peter Costello, Kevin Rudd and Wayne Swan haven’t even noticed. And it’s not our interest rates and a possible rise next month.

The big animal being ignored is the US housing slump and the way everyone in financial markets seems to have blithely tuned out and moved on after the US Federal Reserve’s interest rate cut. The Reserve Bank has noticed it and is watching closely. It could be the only thing that stops interest rates here from rising, if the US financial markets go south again.

The RBA will keep a close eye on what the US Federal Reserve does at its meeting the week after next, especially what it says about the economy and the chances of a recession.

Some say it’s all about “decoupling”, with the world economy not as influenced by the US, as China is the big driver. In the US, “decoupling” is now taken to mean how the US economy is split, with housing a problem but not dragging to rest of the economy with it into a black hole of recession.

Well, that’s in doubt: the US housing recession is worsening, not steadying or getting better and there’s a growing feeling that if the Fed cuts interest rates at the end of this month, it will be not to save Wall Street and others, but to try and stop the rest of the economy from sliding off a cliff. And the concern is not so much for the economy as a whole, but also for a repeat of the meltdown in August and worldwide credit freeze breaking out again.

If that happens, China won’t save us, itself or any other economies.

US Federal Reserve Chairman, Ben Bernanke and US Treasury Secretary, Hank Paulson, are the two heavy hitters of US economic management, and they are in tune on the continuing danger to the country’s economic well being from an imploding housing sector. Both have gone out of their way in speeches this week to draw attention to the danger.

The Fed chairman warned on Monday night that the US housing slump will be a “significant drag” on US growth into next year, and that “this current financial stress is not likely to disappear overnight; partly it is an information problem… It is going to take a while for investors to appropriately value these assets.”

That got Wall Street fretting.

24 hours later, Hank Paulson, the US Treasury Secretary (and former senior partner of Goldman Sachs) warned that the downturn in America’s mortgage market would burden the economy “for some time”. The markets started wondering what was going on.

After all, judging by the reaction in sharemarkets, commodity prices and interest rates, the dangers from the subprime mess had gone away, that is, things had “decoupled.” The credit freeze was over, deals were being done, bonds were being sold, takeovers happening and some bank profits were not bad.

Well, overnight we had confirmation that the housing slump is deepening with new homes starts down sharply again last month. Not that it was “new” news. We have known the figures on housing starts were coming as they do every month; what surprised was the size of the fall, again.

The latest figures from the US Commerce Department suggests America’s housing slump, especially new homes, could be much deeper than thought and could become a bigger drag on the overall economy than previously feared. Housing starts fell 30% from last September and are now at their weakest level in 14 years. The report showed the pace of housing starts dropped 10% in one month to an annual rate of 1.19 million, compared to a 1.33 million rate in August.

Housing permits, which are a sign of builders’ confidence in the health of the market, slumped 7% to an annual rate of 1.23 million from 1.32 million in August. That’s lower than forecast and the lowest level of permits in 12 years: they are now off 26% from a year ago. In fact US housing starts are now half what they were at the start of 2006.

The figures also raise the prospect that if the US Federal Reserve cuts rates at its two day meeting on 30-31 October, it will be to try and avert a recession and not to relieve the stresses on Wall Street.

The US Mortgage Bankers Association said the glut of new and existing homes on the market will grow as many buyers will have difficulty obtaining loans: that will drive house sales and prices lower well into 2008, with no sign of a recovery until early 2009.

That overhang of unsold houses is huge: the US Census Bureau reported overnight that there were 180,000 completed new homes for sale at the end of August, just shy of the record 182,000 in May while the US National Association of Realtors says there were a record 4.6 million existing homes on the market at the end of August.

Get Crikey for $1 a week.

Lockdowns are over and BBQs are back! At last, we get to talk to people in real life. But conversation topics outside COVID are so thin on the ground.

Join Crikey and we’ll give you something to talk about. Get your first 12 weeks for $12 to get stories, analysis and BBQ stoppers you won’t see anywhere else.

Peter Fray
Peter Fray
Editor-in-chief of Crikey
12 weeks for just $12.