Sunday, March 16, 2008

U.S. faces severe recession: NBER's Feldstein

Friday March 14, 10:55 am ET
By Ros Krasny

BOCA RATON, Florida (Reuters) - The United States is in a recession that could be "substantially more severe" than recent ones, National Bureau of Economic Research President Martin Feldstein said on Friday.

"The situation is very bad, the situation is getting worse, and the risks are that it could get very bad," Feldstein said in a speech at the Futures Industry Association meeting in Boca Raton, Florida.

"There's no doubt that this year and next year are going to be very difficult years."

NBER is a private sector group that is considered the arbiter of U.S. business cycles. Feldstein is also a Harvard economics professor and former economic advisor to President Ronald Reagan.

Answering questions from the audience, Feldstein said the downturn could be the worst in the United States since World War Two.

Feldstein said the federal funds rate, the Federal Reserve's benchmark lending rate, is headed down to 2 percent from the current 3 percent.

He added that lower rates from the Fed would not have the same impact in the current downturn, in terms of reviving economic activity.

"There isn't much traction in monetary policy these days, I'm afraid, because of a lack of liquidity in the credit markets," he said.

The Federal Open Market Committee meets on Tuesday to consider its next step on interest rates. Financial markets currently look for a rate cut of 75 basis points, to 2.25 percent, with a moderate chance rates will be slashed 100 basis points.

The Fed's huge new credit facility, announced on Tuesday, "can help in a rather small way ... but the underlying risks will remain with the institutions that borrow from the Fed, and this does nothing to change their capital," Feldstein noted.

Feldstein said the combination of monetary and fiscal stimulus and the falling dollar "will help to dampen the magnitude of the downturn but won't be enough to sustain an expansion."

"The housing situation is getting worse by the day," he noted, as more and more houses drop below 100 percent loan-to-value ratios, encouraging homeowners to walk away from their properties.

More broadly, in global credit markets, "there is a lack of confidence leading to a lack of liquidity ... without credit creation, we can't have economic growth," Feldstein said.

Feldstein noted "powerful forces (that) will continue to drive inflation higher." And while inflation expectations are still relatively well contained, "you wonder how long that's going to last," he said.

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