Recession watch

My new column for National Journal is about mounting fears of recession next year. (lt starts with a discussion of a recent piece for the FT by Larry Summers. That article is here.)

Alarm about the state of the economy and the risk of outright recession next year continues to mount. In the Financial Times on November 25, former Treasury Secretary Lawrence Summers -- a more astute or experienced observer would be hard to find -- raised eyebrows when he seemed to put the chances of recession at better than 50-50, even assuming that policy is changed to address the danger:

Three months ago it was reasonable to expect that the subprime credit crisis would be a financially significant event but not one that would threaten the overall pattern of economic growth. This is still a possible outcome but no longer the preponderant probability. Even if necessary changes in policy are implemented, the odds now favor a U.S. recession that slows growth significantly on a global basis. Without stronger policy responses than have been observed to date, moreover, there is the risk that the adverse impacts will be felt for the rest of this decade and beyond.

Summers points to three main factors. First, the housing market continues to tank. There are signs (in derivatives markets) that house prices may eventually fall by a quarter from their peak -- about as big a drop as between 1925 and 1933, the only other housing-market crunch that comes close. So far, the market is not even halfway there. Second, the implications of all this turmoil have hardly yet begun to work their way through the economy. Mortgage foreclosures could double next year. Banks and other financial firms have to date acknowledged losses arising from the crisis of only around $50 billion; actual losses are undoubtedly much bigger, some think as high as $400 billion. Third, the flight to quality in credit markets continues, meaning that troubled banks will find it harder and more expensive to attract capital, just as their need to do so is at its greatest.

What, then, are the remedies? Summers wants the Fed to "get ahead of the curve" and ease interest rates more aggressively. He says that fiscal policy should be on standby to deliver a big new stimulus. And he wants new institutional measures to deal with the credit contraction. The Treasury sees the so-called superconduit as part of the answer -- in effect, a coordinated mutual support arrangement in which banks get together and acquire assets from the weakest -- but Summers is skeptical. He wants details: So far, he says, this plan is too vague.

In addition, Summers calls for bolder steps to keep finance flowing to creditworthy homebuyers, either through government-supported direct lending or through expanding the operations of Fannie Mae and Freddie Mac (the "government-sponsored entities" that channel finance to mortgage lenders). He also wants regulators to go further in helping distressed mortgage borrowers refinance their debts, for instance by establishing standard templates for restructuring, instead of treating every instance case by case.

The Summers agenda seems to make good sense, so one is bound to ask, why is all this not happening already?

The rest of my NJ column tries to explain. You can read the whole thing here (free link expires in a week).