Credit market turmoil has driven the US into a recession and may topple some of the nation’s biggest banks, said Kenneth Rogoff, former chief economist at the International Monetary Fund.
“The worst is yet to come in the US,” Rogoff said in an interview in Singapore today. “The financial sector needs to shrink; I don't think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job.”
The US housing slump has triggered more than $500 billion of credit market losses for banks globally and led to the collapse and sale of Bear Stearns Cos, the fifth-largest US securities firm. Rogoff said the government should nationalise Fannie Mae and Freddie Mac, the nation's biggest mortgage-finance companies, which have lost more than 80 per cent of market value this year.
Freddie Mac and Fannie Mae “should have been closed down 10 years ago,” he said. “They need to be nationalised, the equity holders should lose all their money. Probably we need to guarantee the bonds, simply because the US has led everyone into believing they would guarantee the bonds.”
US Treasury Secretary Henry Paulson asked Congress on July 13 for emergency powers to inject “unspecified” amounts of government funds into the companies if necessary.
Shares Slump:The mortgage lenders have been battered by record delinquencies and rising losses. Fannie Mae fell in European trading to the lowest in 19 years today amid concern the government-chartered companies will fail to raise the capital they need to offset losses. Freddie Mac slid 25 per cent yesterday to the lowest since January 1991.
Banks repossessed almost three times as many US homes in July as a year earlier and the number of properties at risk of foreclosure jumped 55 per cent, according to RealtyTrac Inc, an Irvine, California-based seller of foreclosure data. US builders probably broke ground on the fewest houses in 17 years last month, according to a Bloomberg News survey.
Rogoff told a conference in Singapore today that the credit crisis is likely to worsen and a large bank may fail, Reuters reported earlier. Rogoff, 55, is a professor of economics at Harvard University. He was the IMF's chief economist from August 2001 to September 2003.
“Like any shrinking industries, we are going to see the exit of some major players,” Rogoff told Bloomberg, declining to name the banks he expects to fail. “We’re really going to see a consolidation even among the major investment banks.”
IndyMac Bancorp: IndyMac Bancorp Inc, once the second-largest US independent mortgage lender until it was seized by regulators July 11, filed for bankruptcy protection Aug 1, three weeks after it was taken over by the Federal Deposit Insurance Corp amid a run by depositors that left it strapped for cash. Bear Stearns collapsed in March and sold itself to JPMorgan Chase & Co for $10 a share.
“The only way to put discipline into the system is to allow some companies to go bust,” Rogoff said. “You can't just have an industry where they make giant profits or they get bailed out.”
The world’s largest economy is already in a recession, and the housing market will continue to deteriorate, Rogoff said. The US slowdown will last into the second half of next year, he said, predicting a faster recovery in Europe and Asia.
The Federal Reserve, which has left its key interest rate at 2 per cent after the most aggressive series of rate reductions in two decades, risks raising inflationary pressures, he said.
“Rates are too low,” Rogoff said. “They must realise we're going to get inflation if things stay where they are. They need to raise rates but I don't think they are going to because they're way too nervous.”
