A pledge to slash interest rates by the head of America’s central bank last night failed to stem the selling of shares on Wall Street amid fresh evidence that the "freefall" in the housing market is contaminating the rest of the world’s biggest economy.
US dealers shrugged aside reassurances from Ben Bernanke that the Federal Reserve was ready "to take substantive additional action as needed to support growth". A 300-point slide in the Dow Jones industrial average last night meant the index had lost 1,100 points since the start of the year. The broader-based S&P 500 index fell nearly 3% yesterday. The Nasdaq was also sharply down.
Bernanke said losses in the US sub-prime mortgage market may have reached $100bn (£50bn) so far and could climb, but would not top $500bn. "Within the specific category of sub-prime, adjustable-rate mortgages, the total outstandings are about a trillion dollars. So, the limits to possible losses must be less than half of that," Bernanke told the House of Representatives budget committee.
"I see, so far, about $100bn but it certainly could be several multiples of that as we go forward and the delinquency [arrears] rates and foreclosure rates rise," he said, noting 20% of sub-prime mortgages are delinquent.
A fresh batch of poor economic news added to the gloom, leading to pressure on the dollar and a drop in oil prices. Housing starts fell to their lowest level in 16 years, with a 14% drop in December to an annualized rate of 1.006m. Sandra Pianalto, president of the Cleveland Federal Reserve, said the residential housing market appeared to be in "freefall".
Signs that problems from real estate were spreading to the rest of the economy came from the monthly snapshot of activity from the Philadelphia Federal Reserve, which fell sharply to its lowest level since October 2001 – the month after the 9/11 terrorist attacks.
Bernanke admitted in testimony to Congress that the economy was "suffering", adding that recent information "suggested that the baseline outlook for real activity in 2008 has worsened and that the downside risks to growth have become more pronounced".
The Fed chairman said higher energy prices, a weaker stock market and falling house prices would weigh on consumer spending this year. "Consumer spending also depends importantly on the state of the labor market, as wages and salaries are the primary source of income for most households. labor market conditions in December were disappointing."
Bernanke said he was in favor of a short-term fiscal boost – tax cuts or spending rises – to help growth, but said any package should be "implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next 12 months or so".
Nick Parsons, head of strategy for NAB Capital, said the Dow had lost 1,500 points since the Fed first cut interest rates last autumn. "We are moving from a correction into a bear market," he said. "The Fed is not in control of this situation. The only way it can get in control is by slashing rates and destroying its credibility."
Futures markets in New York have fully priced in a half-point cut from the Fed at the end of January, a move that would take them to 3.75%. Trading yesterday indicated a 44% chance that the central bank would take the unusual step of reducing rates by three quarters of a point. The view on the possibility of a 0.75 percentage point cut was 32% just before Bernanke’s testimony.
In London, an early rally in shares was reversed after the start of business in New York. The FTSE 100 lost 40.5 points to close at 5902.4…y