US Economic Picture: How Bleak Will It Get?
After one of the most tumultuous weekends Wall Street has ever seen, how much bleaker is the outlook for the U.S. economy, the parts where most Americans work, live, borrow and save?
'The simple answer is: We don't know,' J.P. Morgan Chase economist Bruce Kasman said Monday, discarding the confidence forecasters usually demonstrate in predicting the economy's growth rate to the nearest tenth of a percentage point.
The direction of the economy turns on something hard to predict: Do the events of the weekend make lenders and investors even more cautious and reluctant to take risks, thus choking off credit to consumers and companies and strangling the U.S. economy? Or, does Black Sunday mark a catharsis in the prolonged financial crisis, the moment when bankers faced reality, took their losses and restructured their industry?
Early signs were mixed. The nightmare didn't arrive when markets opened Monday. Stock markets around the world fell, but the declines were modest next to headlines that Lehman Brothers was filing for bankruptcy, Merrill Lynch was selling itself to Bank of America and insurer AIG was still seeking a rescuer with deep pockets. And financial markets seemed to function reasonably smoothly.
But the already wide gap -- the 'spread' in market lingo -- between yields investors demand on risky securities and those demanded on safe U.S. Treasury securities widened significantly. Those spreads are a key reflection of confidence (or lack thereof) among investors and a measure of the extent to which financial conditions are constraining the economy. The question now is how much wider those spreads get.
'How much does the price and availability of credit change? Where are we going to be three weeks from now in terms of credit spreads, the actual rates consumers and corporate pay?' Mr. Kasman asked. Mortgage rates have fallen since the government seized control of mortgage giants Fannie Mae and Freddie Mac, he noted, wondering how much of that might be reversed in coming days.
Among all the uncertainties confronting the economy, the willingness and ability of banks and other financial firms to lend is among the most important. With big and unanticipated losses eroding their capital cushions, financial firms have to raise new capital or to contract lending to levels commensurate with reduced capital. Raising capital is tough, as AIG, Freddie Mac and Lehman show. Contracting lending may be prudent for every individual firm but devastating to a modern economy that relies on credit to fuel growth.
The U.S. economy is in what former Federal Reserve governor Laurence Meyer describes as a 'danger zone,' close to if not in recession. Employers have reduced payrolls every month this year, eliminating 605,000 jobs in all. The unemployment rate has climbed to 6.1% from 5%, representing an increase of 1.8 million in the ranks of the those officially deemed unemployed since December. And the Federal Reserve said Monday that output of American factories dropped a sharp 1.1% in August, mostly but not entirely because of cutbacks in the auto industry. Factory output outside autos has fallen or been flat for five months, and factory output is running 1.9% below year-ago levels.
Still, the biggest financial shock to the global economy since the Great Depression hasn't -- at least so far -- been accompanied by the usual symptoms of deep recession. The economy, for instance, shed more jobs in the first eight months of 2001, after the stock-market bubble burst, than it has so far this year. And the government says the economy contracted in the last quarter of 2007 but grew in the first and second quarters -- and forecasters say it appears to be growing in the soon-to-end third quarter.
Why isn't it worse?
'It's a great question,' says Mr. Meyer, now a private forecaster. 'The economy was really strong going into the housing correction in 2006. It had the strength to withstand the housing shock. Then you get the credit shock. The Fed eased -- by past perspective -- incredibly aggressively. That significantly offset the deteriorating financial conditions which, with rising oil prices, were enough to stagger the economy, bringing it close to recession. But you've got to appreciate the resiliency.'
As housing, autos and financial sectors deteriorated, an export boom arrived at just the right moment. Indeed, foreign trade has provided the bulk of growth in the U.S. for the past several months. With economies outside the U.S., particularly in Europe, slowing substantially, America's export boom is likely to wane
Even before the weekend's events, 14 of the 51 economists responding to a Wall Street Journal survey earlier this month predicted the U.S. economy would contract in the fourth quarter as the adrenaline of fiscal-stimulus checks and earlier rate cuts wane. The average of the 51 forecasts was fourth-quarter growth at a meager 0.7% rate, so slow that it will push the unemployment rate higher. Lower oil prices are welcome and better for the global economy than higher oil prices. But Monday's drop is best seen as a symptom of waning global demand than a source of strength.
The continuing decline in house prices is eroding homeowners' wealth and discouraging new construction, but the economic ill-effects are greatly magnified as house prices erode the value of securities held by major financial firms. 'Mortgage credit losses deplete the equity capital of leveraged financial institutions and persuade them to reduce their financial leverage,' Goldman Sachs economist Jan Hatzius said in an analysis presented at the Brookings Institution last week. 'This reduces the supply of credit to households and nonfinancial businesses.'
Estimating the impact of losses on amount of credit supplied by banks, securities markets, and Fannie Mae and Freddie Mac, Mr. Hatzius estimated that the crisis could reduce the U.S. economy's growth rate in 2008 and 2009 by an average of 1.8 percentage points per year -- and that assumes Fannie and Freddie continue to expand their mortgage business aggressively.
None of this comes as a surprise to the former Princeton University professor who now chairs the Federal Reserve, Ben Bernanke. He made his mark in academia arguing the importance of what he and his collaborators called 'the credit channel,' the ways in which the financial health of borrowers and banks affect the economy and helped cause the Great Depression.
David Wessel |
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