The FOMC statement did say that “credit conditions have become tighter for some households and businesses,” but the statement expressed the judgment that economic growth would continue at a moderate pace in coming quarters.

Financial market conditions deteriorated markedly in the wake of the Aug. 7 FOMC meeting, forcing the Fed to inject large amounts of reserves into the banking system just to keep the effective federal funds rate close to the unchanged target rate — 5.25%.

In the midst of this turmoil, the Fed issued a public statement on Aug. 10 saying that the central bank would continue to keep the funds rate on target and reminding the markets of the existence of the discount window that banks could go to for credit (at a 1% penalty rate).

The Fed’s words and actions at this stage of the game prompted many analysts and market participants to charge that the Fed under Chairman Ben Bernanke was “out to lunch” in the midst of an evolving financial market crisis.

Market turmoil increased further in following days, and on Aug. 17 the Fed turned more decisive — announcing a half-point cut in the cost of primary credit at the discount window and amending the balance-of-risk statement that had been issued at the conclusion of the Aug. 7 FOMC meeting.

The revised statement focused on the downside risks to economic growth and dropped the long-standing inflation concern. [return to top]
 

The projected easing of monetary policy is sorely needed since the recent market turmoil has tightened overall financial market conditions as investors have stampeded toward credit quality. This process has driven down risk-free interest rates (i.e., Treasury rates) but widened quality spreads in virtually all private markets — raising credit costs for all but the best credit risks.

The mortgage market has been hardest hit, but the cost of funds for all but AAA-rated businesses has climbed as well. [return to top]
 

Mortgage rates have risen substantially in subprime, Alt-A and jumbo loan components (above the GSE conforming loan limit), and serious availability problems have erupted as corresponding components of the mortgage-backed securities markets have frozen up.

Adjustable-rate mortgages now are quite rare in these components of the mortgage market, and the only segments now operating “normally” are the small FHA and VA markets (with Ginnie Mae securities backup) and the prime conventional conforming market that’s served by Fannie Mae and Freddie Mac.

These markets accounted for about half of total mortgage originations in 2006, and the shares now are rising substantially. [return to top]
 

We’ve been surveying builders on these topics since early this year, when the subprime market started to melt down, and it’s clear that the tightening wave that hit during the past month has had the most severe impacts so far.

Our current survey shows that the most recent wave of credit tightening has had adverse impacts on home sales at nearly two-thirds of single-family builders, with the heaviest impacts on large companies in the West.

Furthermore, the credit problems have pushed up sales cancellations at more than one-third of the companies, particularly for big builders in the West.

When asked about credit problems in various components of the mortgage market, the builders ranked degrees of seriousness as follows ― subprime, Alt-A, prime jumbo and prime conforming.

On the other side of the coin, one-fifth of survey respondents said FHA-insured mortgages are helping to fill the gaps and one-eighth said VA-guaranteed loans are filling in to some degree. [return to top]
 

Compared with forecasts put in place at the beginning of this year — before the mortgage market meltdown began during the first quarter ― our forecasts for total housing starts in 2007 and 2008 now are lower by 11% and 24%, respectively.

In historical terms, we now figure that housing starts for 2008 — 1.3 million will be the lowest since 1993. Our revised housing forecast definitely has troubling implications for the economic expansion.

The projected downswing in Residential Fixed Investment takes a heavy toll on GDP growth in the second half of this year, subtracting about a percentage point in both the third and fourth quarters. The drag from housing eases off during the first half of 2008, and we expect RFI to resume slow positive growth during the second half.

But as I’ve been saying all year, our baseline (most probable) housing forecasts still are surrounded by wide bands of uncertainty. [return to top]