Weekend Contemplation - Dr. Feldstein Says the Recovery Could be Long and Slow

Finally, some realistic comments about the condition of the US economy. Debate as much as you like but it looks like the recovery will be long and slow. The housing crisis is really causing major problems in the capital markets and at the banks. If Fannie and Freddie go through with the reduced mortgage purchases like they claim this will really slow down the the housing market. Throw into the mix a weak consumer and this could be tough. If you don't believe me go to the car lots and see the mark down in cars. Or go to the grocery store and ask them how business is. If you disagree, tell me what is going to turn the market around, I am dying to know. Text in bold is my emphasis. From Market Watch:

There is a palpable sense here at the Federal Reserve's exclusive retreat that the road to recovery will be a very long one for the U.S. economy.

A slowdown in the third and fourth quarter is widely expected, but many economists see a long stretch of stagnant conditions.

"I am worried," Martin Feldstein, a Harvard University professor, and leading economist, said in an interview.

"I think the downward spiral of house prices could be a very serious problem to the economy. There is no evidence that is going to stop," he said.

The danger is that this spiral becomes self-reinforcing -- with foreclosures leading to lower prices leading to more foreclosures, he said.

Although the Federal Reserve's latest forecast sees a rebound next year, Feldstein questioned what factors are behind the forecast.

"It is not clear where the lift will come from," Feldstein said.

Alan Sinai, chief global economist at Decision Economics Inc, forecast that the U.S. will soon slip into a recession lasting as long as any in the post-War history.

There were two recessions lasting roughly 16 months, one in the mid-1970s and another in the early 1980s.

"What is daunting now is that we've got a lot to go. We now have a weak consumer and after some amount of time, we'll have a weak business sector and a major global slowdown in growth. All of this will reverberate back into the economy," Sinai said.

"And the big wild card is how long does it take to deleverage, consolidate, squeeze down costs and then have some liveliness in the business of financial service,?" he added.

"That process time-wise, along with financial problem, could easily take a year," he said.
Feldstein said the market doesn't reflect this risky outlook because some sectors are still reporting healthy profits.

But it is also true that economists at major Wall Street firms are not as pessimistic as Feldstein or Sinai.

"I think the most likely scenario is by early next year things start to work themselves out," said Lewis Alexander, chief economist at Citigroup.

"I don't think we're likely to get a very robust recovery ... but I don't think a more disastrous scenario is the most likely case either," Alexander said.

Mickey Levy, chief economist at Bank of America, agreed.

"I think six months from now we will start to see the light at the end of the tunnel of the housing crisis," Levy said.

The declines in home construction will be near the end and "at that point, some of the uncertainty about how much home prices will fall will start to dissipate," he said.
Inflation

There was no consensus about the outlook for price pressure.

Levy said the Fed will soon begin to prepare markets for a rate hike by the end of the year, providing the Bush Administration completes a credible nationalization of Fannie Mae and Freddie Mac.

"That will open the door for the Fed hiking rates," Levy said.

Despite his weak growth outlook, Sinai said he would also support a small rate hike as a signal that the Fed is committed to stable prices.

Sinai said the Bush Administration and the Fed's response to the financial market turmoil over the past year is inherently inflationary.

For his part, Feldstein said he agreed with Fed chairman Ben Bernanke, who yesterday signaled that the central bank was prepared to be patient about hiking rates given the recent decline in oil prices.