Bill Jamieson: Confidence needed to stop the Recession Express in its tracks

Published on Thursday 27 November 2008 21:04

CLEAR the line and get out the way! The Recession Express is smashing through a high street near you. Woolworth, MFI and a raft of struggling businesses leveraged to Hell and beyond are being crushed like matchsticks as the Duchess of Doom batters on.

What can be done to halt the runaway train?

Flaky though Alistair Darling's Pre-Budget Report may have been, and its arithmetic as solid as a Northern Rock balance sheet, there are good grounds for believing that this engine of destruction can be slowed and that a recovery will be underway in the second half of next year. I have two reasons for this, utterly unfashionable, optimism: one grounded in events in America and one based on developments here.

And how right readers are to look askance at hope after a year such as this. With every month the runaway recession train has gathered speed and thundered on. The station it has just whizzed through? It is an airless, dead-end hole called Nothing's Working.

I've lost count of the armoury fired at the recession express, from silver bullets to grand bazookas. In America, we have had interest rate cuts, the Bush fiscal stimulus, huge amounts pumped into wholesale money markets, bank rescues and collapses, the Hank Paulson bazooka, the Hank Paulson Bazooka Mark II, the underpinning of mortgage banks and the world's biggest insurer, a new, co-ordinated round of interest rate cuts, and now the bail-out of Citigroup.

In Britain, we have had rate cuts, bank nationalisations, recapitalisations and rescues, awesome sums pumped into money markets, a record 1.5 per cent cut in rates and now a 20 billion reflationary budget and billowing government borrowing: anything to halt this iron cataclysm of steam and fire. Still it powers on, smashing those Liar's loan banks and debt-laden clapperboard lean-tos that came to pose as solid oak companies.

Fiscal and monetary policy round the world has now gathered the guns at the last stop on this murderous line: a sunless, eerie, uncharted canyon called Whatever It Takes. In case you missed the signpost, "we are dealing", said Hank Paulson this week, "with a historic situation that happens once or twice in a 100 years."

What a change from the soundbites of a few months ago about the US economy being fundamentally strong.

Tuesday saw the firing of an almighty fusillade across this canyon, and it offers the best prospect yet of slowing the nightmare express. The US Federal Reserve launched an $800 billion blaster to buy up mortgage bonds issued by giant lenders such as Freddie Mac, Fannie Mae and the Federal Home Loan banks. The polite version is "quantitative easing". The crude expression is "printing money". But if that's what it takes, that is what will be done.

By Wednesday the yield on US ten-year government bonds fell below 3 per cent for the first time since this crisis began, and to its lowest for 50 years.

Why is this important? Because that is the marker bond for long-term, US fixed-rate mortgages. On Wednesday the yield on Fannie Mae's 30-year mortgage bond fell by as much as 60 basis points to 4.81 per cent, its lowest level since last January. Other mortgage product rates have also fallen.

And the ten-year bond rate is likely to go lower yet. Why? Because the Federal Reserve chairman Ben Bernanke told us so. In a little remembered speech six years ago on Deflation: Making Sure "It" Doesn't Happen Here, he outlined the importance of bringing down medium and longer dated yields as a means of stimulating spending.

The route the Fed has taken this week is more direct– a liquidity injection directed straight at the US mortgage market. But it has had the effect of lowering both mortgage rates and corporate bond yields – and that is something that all the firepower of the past ten months – the bazookas and super bazookas and silver bullets – failed to do. And still to come is the "Obama Blaster" – a reflationary package in January reckoned at 1 per cent of US GDP.

The rally in the bond market is particularly positive for equity markets and critical in determining whether the rebound can be sustained. Says Brewin Dolphin economist Mike Lenhoff: "There is a growing sense that, as a result of the 'biggest and most energetic policy response of our time'... it's the valley that lies ahead and not the abyss."

What of the UK? Neither this week's VAT cut nor the political giveaway shrapnel will have much effect. But, by the summer of next year, those deeply depressing monthly house price surveys should be showing an easing of the rate at which house prices are falling as year-on-year comparisons catch up with this year's fall. House sales figures, too, will begin to moderate. The conditions will start to fall in place for confidence in the housing market to return. By then we should also have further interest rate cuts from the current 3 per cent level down to 1.5 per cent or even lower.

By this time next year the mood in the housing market and the wider economy will be quite different to the mood now. We will have something approaching hope compared with the fear that is gripping business and household wallets at present.

Can it be speeded up by government finger wagging at the banks and threats of outright nationalisation? I do not believe so. Buyers cannot be induced nor lenders browbeaten into a state of confidence while house prices are still falling sharply and business prospects look none too good. What is the point of Lord Mandelson ordering banks to lend badly?

Time is needed for the shocks to be absorbed and the measures announced to take effect. But an upturn in the second half of next year is not a pious hope. It has every good prospect of coming true.