Economy called likely to slide

pace is unclear

Economists focus on negative factors

December 25, 2007|By James P. Miller | James P. Miller,Chicago Tribune

Because the U.S. economy is so astonishingly complex and subject to so many variables, economists can't predict recessions. They can't even say for certain one is under way until months after it has begun.

What economic experts can do is establish probabilities of a financial meltdown.

And with the U.S. economy already on the ropes as it enters 2008, most experts say things are almost certain to get worse.

The question that can't yet be answered: How much worse?

The housing market is still falling and still eroding consumers' confidence. Higher fuel costs have drained households' available spending money much the same way a stiff new tax increase would.

Meanwhile, credit markets have tightened sharply since late summer, making lenders skittish about making crucial loans.

Those negative factors have teamed up to slow the economy's momentum, and in the year ahead they could tip the financial system into outright recession.

Of course, nothing is certain, but "consensus is moving from whether or not there will be a recession to how severe of a recession it will be," Jack Ablin, chief investment officer of Harris Private Bank in Chicago, told investors recently.

JPMorgan economist Bruce Kasman offers a less downbeat reading, contending that while 2008 promises to be an economic "year of living dangerously," he anticipates an economy that "bends but doesn't break." Kasman figures the risk of a recession in the next 12 months at about 35 percent.

Economic growth in the first quarter of 2007 was dreadful, but the second and third quarters showed a surprising amount of pep. Although falling house prices kept consumers from refinancing their homes and extracting big sums of cash the way they had grown accustomed to doing during the long housing boom, consumers still kept spending at a reasonable clip. The fourth quarter now coming to a close will likely be as weak as the first quarter.

The final numbers aren't in yet, but experts figure the nation's inflation-adjusted gross domestic product will likely turn out to have grown 2.2 percent in 2007, weaker than the 2.6 percent that was the consensus at the start of the year but far from a disaster.

In the year ahead, many experts are figuring the inflation-adjusted rate will weaken slightly, to 2.1 percent or even a figure below 2 percent. The Fed itself is projecting 2.45 percent growth in 2007 and a lackluster 2.15 percent expansion in 2008.

Depending on which econometric model or leading economic indicators you prefer, the probabilities for a recession currently are "anywhere from 50 percent to 100 percent," said Merrill Lynch economist David Rosenberg.

Investors, he said in a recent report to Merrill clients, "should be taking recession risks very seriously," but to date the stock market hasn't fully factored in the prospect of deepening profit damage for companies in economically sensitive cyclical sectors.

Most experts could spot the dangers facing the economy a year ago, such as the housing sector's calamitous fall-off and the economic drag of high fuel costs. But the wild card for 2008 is likely to be a factor that barely registered on most experts' list of concerns a year ago: the state of the credit markets.

During the housing boom, investment banks bought hundreds of billions of dollars' worth of financial instruments backed by mortgage loans issued to U.S. borrowers. After the residential bubble burst, consumers with shaky credit prospects began to default in growing numbers on the subprime mortgages they had taken out, and the value of the mortgage-backed securities Wall Street had so ardently peddled suddenly dropped.

Since the global scope of the problem became apparent in late summer, many banks have taken multibillion-dollar write-downs to reduce the value of the so-called collateralized debt offerings they are stuck with. Those charges, or even the prospect of having to take such write-downs in the future, have in turn reduced capitalization and made lenders wary about making loans to even solid borrowers.

It's not clear how much more of the toxic debts exist on bankers' books, and as a result the global credit markets have become tense and hesitant, with lenders fretful about making loans to each other. And that credit crunch, which lingers despite efforts by the Fed to inject large quantities of cash into the financial system, is casting a hard-to-quantify shadow over the broad economy's health in 2008.

Still, the economic Grinch could be kept at bay, Action Economics' Michael Englund noted recently, pointing out that to date there has been "surprisingly little evidence" that the turmoil in the financial markets is causing consumers to cut their spending.

Near-term economic growth is clearly slowing, he said, but the continued resilience in spending by U.S. households "argues against a sustained slowdown" in the year ahead.

James Miller writes for the Chicago Tribune.

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