Economic Drag

Paulson, Bernanke gloomier on economy
by William Neikirk

Earlier this year, the U.S. Treasury and the Federal Reserve downplayed the risk of the housing correction to the U.S. economy. But this is no longer true. Economic decline, a credit crunch, home foreclosures, financial market turmoil and fear among investors are enough to tease out true candor.

Both Treasury Secretary Henry Paulson and Fed chairman Ben Bernanke have joined the chorus of Americans who view the housing correction's dangerous financial tentacles as a real and present economic danger.

Paulson, forsaking his cheerleading economic role, said in a speech today that "despite strong economic fundamentals, the housing decline is still unfolding and I view it as the most significant risk to our economy. The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth."

Only a day earlier, the Treasury chief had helped arrange the creation of a private-bank fund of as much as $200 billion to prevent a rapid decline in mortgage-backed assets that have been virtually impossible for their holders to unload. With this move, Paulson hoped to restore credit markets to health and smash a credit crunch in business lending. Big banks went along.

In his speech today, he called on Congress to take a number of steps to help Americans who are threatened with foreclosure on homes purchased with risky loans. And, he said, "we also need to make some changes in our laws and rules in order to prevent some of the excesses and the abuses of the last few years from housing again."

He added: "The ongoing housing correction is not ending as quickly as it might have appeared late last year. And now it looks like it will continue to adversely impact our economy, our capital markets, and many homeowners for some time yet."

How long is "some time yet?" Your guess is as good as the next person's.
Bernake gave a speech Monday that gave a clue. "The further contraction in housing is likely to be a significant drag on growth in the current quarter and through early next year," he said.

What does "early next year" mean? Most people would probably say anytime from March through April.

But Bernanke added a caveat.

He said it is "too early" to assess how much consumer and business spending will be hurt by the housing correction and the related credit crunch. The Fed chairman appears to be preparing us for the possibility that the "significant drag" on growth could last much longer.

In concluding his remarks, he had some sobering thoughts.

"This has been a challenging period. Conditions in financial markets have shown some improvement since the worst of the storm in mid-August, but a full recovery of market functioning is likely to take time, and we may well see some setbacks."

He said investors "have not yet fully regained confidence in their ability to accurately price certain types of securities," obviously meaning mortgage-backed securities.

"The ultimate implications of financial developments for the cost and availability of credit, and thus for the broader economy, remain uncertain."