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A Recession, If It Comes, Could Be
Worse Than Those of Recent Past
By JUSTIN LAHART
22/01/08 "WSJ" -- -- The U.S. has suffered recessions only twice
in the past quarter century, and both were short and mild. But
there are good reasons to fear that the looming recession, if it
arrives, could be worse.
Housing is in the midst of its worst downturn since at least the
1970s. That has led to a meltdown in the nation's mortgage
market; with financial firms struggling to make sense of their
losses, they are making it harder for even credit-worthy
borrowers to get loans. The combination of heavy debt loads,
still-high energy and food prices and a weakening job market has
households tightening their belts. Consumer spending, long a
bulwark of the economy, is faltering.
That sets the stage for something more severe than the 2001
recession, which spanned just eight months, says Merrill Lynch
economist David Rosenberg. During that slump, in which gross
domestic product declined by a slight 0.4%, quarterly consumer
spending slowed but never contracted -- the first time that
happened during a recession since the 1940s.
The eight-month recession that ended in early 1991, when a
housing downturn and credit problems sapped the economy, is a
better guide. From its peak to its trough, GDP shrank 1.3%, and
consumer spending slipped.
Today's housing debacle is even worse, says Mr. Rosenberg, and
the financial crisis it has precipitated is far more severe.
University of Maryland economist Carmen Reinhart and Harvard
University economist Kenneth Rogoff agree. They say the current
crisis appears on track to be at least as bad as the five most
catastrophic financial crises to hit industrialized countries
since World War II.
If those past experiences are any guide, the economy is in
trouble, they argue in a recent paper. Indeed, "if the United
States does not experience a significant and protracted growth
slowdown, it should either be considered very lucky or even more
'special' than most optimistic theories suggest," they write.
One reason that large crises inflict so much damage is that
financial institutions have a hard time getting a handle on how
bad their losses will be, and that uncertainty makes them less
willing to lend. Citigroup Inc. and Merrill Lynch & Co. each
reported billions of dollars in losses last week that were in
addition to the billions in losses they reported in the fall.
Citigroup said it was building its loan-loss reserves for auto
loans and credit-card debt, in addition to mortgages, and that
it was tightening credit-card lending standards.
"Part of the problem is just not knowing," Ms. Reinhart says.
"The longer the process of not knowing what the losses are
takes, the longer the resolution takes." Japan was the extreme
example, she says. Japan's inability to appropriately gauge the
losses from the collapse of its 1990s real-estate and stock
bubble led to a "lost decade" of economic growth.
A critical difference between the U.S. and Japan is that the
Federal Reserve has been cutting the target for its benchmark
federal-funds rate and appears ready to cut it more deeply,
whereas the Bank of Japan was still raising rates a year after
Japan's bubble began to collapse. Also, Congress and the White
House are both promising a fiscal-stimulus package, with Fed
Chairman Ben Bernanke pushing for a plan that would help boost
spending this year.
Businesses, at least those outside of the banking and housing
sectors, might also take some of the sting out of a recession.
Their finances are in far better shape now than they were in
2001, and credit so far is still widely available. As they
repaired their balance sheets in the wake of the 2001 recession,
companies were also slower to hire than in past economic
expansions. That may mean they won't be able to cut jobs as
deeply, says Goldman Sachs economist Jan Hatzius.
Robert Gordon, an economist at Northwestern University who is
also a member of the National Bureau of Economic Research
committee that determines (usually long after the fact) when
recessions begin, is hopeful that overseas growth may continue
to bolster the U.S. economy. He notes that exports, which have
been growing rapidly and account for more than twice as large a
share of GDP as home construction does, will continue to post
strong growth, easing the pain of the housing decline.
Still, he thinks a recession is probably coming and that the
challenges facing consumers, in particular, are more severe than
they were in the two previous downturns. In addition to the
housing troubles and mortgage-market woes, higher food and
energy costs are cutting into household budgets, he says.
"While energy is not as important a part of the consumer budget
as it was in the '70s -- nor is food -- nevertheless, the
squeeze will push out consumption in everything else," Mr.
Gordon says. "Across the board, I think we're going to have
significant ongoing pressure in inflation-adjusted retail
sales."
Robert Barbera, an economist at New York trading-services firm
Investment Technology Group Inc., agrees. "Consumers will be
part of this recession in a way that they weren't in 2001," he
says.
Even if the country is in for just a mild recession, the
pressure on spending, coupled with what has happened in the
housing and mortgage markets, may make it feel a lot worse for
most Americans than the past two downturns did.
Write to Justin Lahart at justin.lahart@wsj. com
Copyright © 2008 Dow Jones & Company
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