Bernanke vs. Greenspan: Who Wins?

03/27/2007 12:00 am EST

Focus:

Vivian Lewis

Editor and Publisher, Global Investing

Vivian Lewis, editor and publisher of Global Investing, discusses how the Federal Reserve might react to a continued meltdown in subprime loans and says that if push came to shove it might start loosening again.

The current head of the US Federal Reserve, Ben Bernanke, is being nudged by his predecessor to cut rates now. That is the hidden message of all those cryptic comments by Alan Greenspan about the risk of recession in 2007.

Alan Greenspan wants to reinstate the old "Fed put", a market bet that if the economy is in difficulties or some element of the financial system is tanking, then the Fed will intervene. That happened during Greenspan's watch over everything from the Asian contagion to the ruble rubble to Long-Term Capital's disasters.

But maybe the new Fed is more concerned with inflationary risks from rate-cutting and monetary easing.

While Greenspan has a tremendous following among market watchers, he is now a mere seer, not a maker of policy. And the way the Fed jumps depends on the members of the Fed today guided by Bernanke and not Greenspan.

The present mess over sub-prime lending companies may or may not spread to the economy as a whole. Those owing non-payable mortgages are not a large part of the population and they have not been generators of the home-equity-financed consumption boom.

The delinquency rate on sub-prime mortgages is 13.3 percent, compared to 4.95 percent for the total market and 2.6 percent for prime loans. So, we are only talking so far about a tiny sliver of the mortgage market. How the rest of the financial sector handles the sub-prime meltdown will determine how the markets and the economy behave.

[Respectable lenders] may wind up raising their own lending standards in other areas by excessive amounts to prevent contagion. Emerging markets dependent on foreign bank finance are fewer these days, but if there is a generalized move against risky loans, they will suffer. If there is a general bank drive to impose more conditions on consumer loans, this may derail the whole economy.

But there is at least a chance that the financial sector will survive the sub-prime meltdown without an excessive aversion to risk--and that the US will not need a panic cut in interest rates to stave off a recession.

If the sub-prime problem cannot be contained, the global sell-off will continue. Before that happens, of course, the Fed will ease to avert a recession. It will not tighten the way the pre-Greenspan Fed did over the US savings & loan crisis of the 1980s.

The only clear message I derive from my forecast is that you want to seriously consider yield stocks. In any event, it will take time to see what is coming.

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