ECONOMY - No Quick Fix, Collateral Effect Election 2008

"No Quick Fix to Downturn" by Peter S. Goodman & Floyd Norris, New York Times

Excerpts

As leaders in Washington turn their attention to efforts to avert a looming downturn, many economists suggest that it may already be too late to change the course of the economy over the first half of the year, if not longer.

With a wave of negative signs gathering force, economists, policy makers and investors are debating just how much the economy could be damaged in 2008. Huge and complex, the American economy has in recent years been aided by a global web of finance so elaborate that no one seems capable of fully comprehending it. That makes it all but impossible to predict how much the economy can be expected to fall before it stabilizes.

The answer could be a defining factor in the outcome of the fiercely contested presidential election. Not long ago, the race centered on the war in Iraq.

But now, as candidates fan out across the country, visiting places as varied as the factory towns of Michigan and streets lined with unsold condominiums in Las Vegas, voters are increasingly demanding that they focus on the best way to keep the economy from slipping off the tracks.

The measures now being debated in Washington and on the campaign trail — tax rebates, added help for the unemployed and those facing sharply higher heating bills and, most immediately, a move by the Federal Reserve to further cut interest rates — could certainly moderate the severity of a downturn. Democrats and the Bush administration are considering a package of such measures that could reach $100 billion.

But the forces menacing the economy, like the unraveling of the real estate market and high oil prices, are too entrenched to be swiftly dispatched by government largess or cheaper credit, some economists say.

“The question is not whether we will have a recession, but how deep and prolonged it will be,” said David Rosenberg, the chief North American economist at Merrill Lynch. “Even if the Fed’s moves are going to work, it will not show up until the later part of 2008 or 2009.”

In the view of many analysts, the economy is now in a downward spiral, with each piece of negative news setting off the next. Falling housing prices have eroded the ability of homeowners to borrow against their property, threatening their ability to spend freely. Concerns about tightening consumer spending have prompted businesses to slow hiring, limiting wage increases and in turn applying the brakes anew to consumer spending.

Not everyone is convinced that the American economy is headed for a recession, defined as six months of economic contraction. The economy often serves up indications of distress that later turn out to be false warnings.

But some economists think a recession may have begun in December. In the last two weeks, there have been signs that a substantial downturn may already be unfolding. The Labor Department reported a sharp slowdown in job creation in December. Retailers said that sales last month were extremely disappointing, capping the worst gain for a holiday season in five years. A widely watched index showed manufacturing slowing, despite a weak American dollar that has encouraged growth in exports.

The construction of new homes has already fallen by some 40 percent since the peak in 2006. The sales of new homes have fallen even faster, suggesting that a large oversupply of places to live will continue to drag down prices.

Home prices have dropped by about 7 percent since the peak in 2006, but some experts suggest they could fall by another 15 to 20 percent before hitting bottom.

“There is still a long way to go,” said Nouriel Roubini, an economist at the Stern School of Business at New York University and chairman of the research firm RGE Monitor.

“We’re facing the risk of a systemic financial crisis,” Mr. Roubini said. “It’s not just subprime mortgages. The same kind of reckless lending has been occurring throughout the financial system. And it’s not only mortgages: Now it’s credit cards and auto loans, where we see problems increasing. The toxic junk is popping up everywhere.”

Banks, including commercial banks and investment banks, have so far acknowledged losses of some $100 billion, yet anxiety persists that more large write-offs are coming.

“Firms will go to great lengths to hide or delay reporting losses,” said Paul Ashworth of Capital Economics. “What we know now therefore might only be the tip of the iceberg.”

Wall Street has clamored for the Fed to keep lowering rates, cognizant that cheaper credit is generally good not just for encouraging borrowing and spending but also for corporate profits.

But some economists fear that lower rates will simply provide a short-lived boost at the expense of the economy’s longer-term health: Cheap money encourages foolish investments, they say, which is precisely how Americans came to experience the evaporation of wealth in the Internet era, followed by housing prices rising beyond any reasonable connection to incomes.

“If we have a recession with a modest consumer retrenchment, and the rest of the world holds up, this could be three quarters of disappointment,” said Robert Barbera, the chief economist of ITG. “The risk is a more dramatic decline for the consumer.”

A recession could pack enormous political consequences. Over the last century, the economy has been in a recession four times in the early part of a presidential election year, according to the National Bureau of Economic Research. In each of those years — 1920, 1932, 1960 and 1980 — the party of the incumbent president lost the election.

While tax rebates can encourage spending and generate jobs, Mr. Roubini said, the government cannot afford to unleash the significant amounts — $300 billion or $400 billion — that he believes would be required to ensure a substantial rebound in economic growth.