Inevitable US Recession


The things are clear that the "Housing bubble" initiated by the ultra low ARMs in the Greenspan era due to low interest rates. Now if this asset class loses 35% of its value then it will knock off the 7 trillion US dollar from house assets. The US households have withdrawn about 14trillion dollar by using home as equity since last decade.
So due to loss in the value of the underlying assets it will stimulate default in such asset backed loans. When the default rates rises then financial intermediaries will increase the interest rates to neutralize their losses that will enhance the defaults further. This will lead to credit crunch or reduce demand of high cost credit from US households. Snapping credit lines might put brakes on the US economy which depends on the credit fuelled consumption.

The Federal Reserve board probably has to reduce the rates primarily to cover the losses incurred by the financial intermediaries rather than stimulating the slowing economy.
These moves will fuel the further rise in the commodities in general and crude oil in particular. As these things are price inelastic, it will widen the current account deficit further. This may lead to further loss in the value of dollar which may fuel inflation further due to rising import prices. Rise in the prices of commodities will lead to depressing the consumption of price elastic products such as consumer durable and cars. This will turn in to classic stagflationary situation characterized by the rising inflation and slowing economy.
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This is the inevitable “Double Whammy” situation that US is most likely to face in the year 2008 with huge credit crunch due rising consumer loan defaults and stagflationary situation due to rising commodity prices and crude oil as result of lowering interest rates by Federal Reserve Board.