Former Federal Reserve chairman Alan Greenspan today hails the prospect of a turning point in the turmoil that has swept through the world’s financial markets, saying the troubled US housing market that triggered the crisis will begin to recover in the first half of 2009.

In a strikingly upbeat assessment of the state of the financial markets, Greenspan sees an “eventual thawing” of the world’s frozen credit markets and praises the actions of governments in buying up toxic assets and recapitalizing banks.

Writing exclusively for Emerging Markets at the end of the most turbulent fortnight in modern financial history, Greenspan says the recent slowing in the rate of decline in US home prices was the first “positive note in this long term trauma”.

“More conclusive signs of pending home price stability are likely to become visible in the first half of 2009,” he writes. He says that a 1 million rise in the American population this year combined with the slump in the new homebuilding will lead to a fall of almost 250,000 in the stock of vacant homes in the second half of this year.

The end of the fall in house prices would effectively put a floor under the decline in the value of US housing stock, which provided the collateral for the reckless asset-backed lending that triggered the crisis. “Losses will no longer be prospective,” Greenspan argues.

He says a resolution of the housing crash is a necessary, but not sufficient, condition to end the financial crisis, which will require a return of investors’ confidence in the health of banks and financial institution. An end to falling prices and a clarification of the value of the US housing stock would enable banks and other lenders to see the true value of the trillions of transactions taken out on the back of US mortgages.

Greenspan’s optimistic assessment comes as analysts and commentators are increasingly pinning blame for the crisis on his policies. During his tenure at the Fed, earlier in this decade, he cut interest rates to as low as 1% and strongly supported financial deregulation. His opponents claim that this fuelled the overheating in house prices and financial innovation that resulted in the cash.

Greenspan says the financial crisis will be resolved when investors decide that capital injections into banks and other financial institutions by both the private sector and governments have made them feel confident to hold bank debt again.

“The fundamental issue [is] ... how much overall deleveraging is going to be required to induce global investors to again become committed holders, at modest interest rates, of the liabilities of the world’s financial intermediaries,” he writes.

The high interest rate demanded by investors in banks’ liabilities indicates today’s 10% ratio of equity to assets among worldwide banks was too high. The crucial question is how much additional bank capital was needed to stabilise the financial system.

Greenspan defines it as the level of capital that will restore the LIBOR/OIS spread – the difference between the rate banks charge for loans in London relative to the overnight index swap rate – to its pre-crisis level of 15 basis points compared with 300 basis points yesterday.

“This is the most difficult policy question economists face in the current crisis,” he writes. “The tenacity of the global financial pullback suggests that deleveraging will not come to an end until many percentage points are added to financial intermediaries’ equity to asset ratios.”

The former Fed chief warns that unless new bank capital is forthcoming, the higher capital cushions required by investors would trigger a further asset sell-off that would further depress prices.

Achieving a stable level of both home and other asset prices will depend on how long it takes to reach a new and supportable level of capital and leverage, he says, adding that further injections of equity capital by governments into banks will help stabilize the system.

“Eventually the market freeze will thaw as frightened investors take tentative steps towards re-engagement with risk,” he concludes. “Broken market ties among banks, pension and ledge funds...will become re-established and our complex global economy will again move forward.”

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