Fed to the rescue: Economy is likely headed to recession

Today's economy is starting to look and feel like past downturns. While current forecasts still call for the national economy to just skirt a downturn, now it feels more likely the economy is headed into recession. Parts of the economy are clearly already there. The housing, mortgage, and auto industries are the most obvious cases, Wall St. is now contracting; nondurable manufacturers producing apparel, textile, paper, and furniture are reeling; the print media is in decline; and large parts of retailing are on the precipice. Together, these industries account for more than 20% of the nation's GDP. Regionally, it appears that California, Florida,Michigan, Ohio, Nevada and Wisconsin are now slipping into recession. These state economies account for over 25% of the nation's GDP. Fed to the Rescue At the current 4.5% federal funds rate target, the federal reserve has substantial latitude to rescue the economy by lowering interest rates and offsetting the tighter credit conditions. Surprisingly, fed policymakers seem hesitant to do so. Policymakers said threats to economic growth and of higher inflation were equally balanced. But the risks are not balanced and the economic expansion is coming undone. San Francisco fed president Yellen expressed her concern about recent data on consumer spending. She acknowledged that the much-awaited slowdown in consumption growth is here. Her tone furthers the view that fed policymakers are leaning toward further rate cuts when they meet over the next couple of meetings. Yellen acknowledged that she favors aggressive easing to make sure the fed does not "fall behind the curve." Yellen said economic downturns can be difficult to reverse once they take hold. This hints that she believes more, and possibly more aggressive easing may be needed to steer the economy away from a recession. Banks at risk Major financial institutions are suffering large write-downs on their exposure to the U.S. housing and mortgage markets. Substantially more losses are expected through the remainder of 2007 and into 2008. Based on early estimates losses on mortgage-related investments range from $275 billion to over $300 billion. There is danger that a number of major financial institutions may fail or become so capital-impaired they are forced to severely rein in their activities. Capital reductions of $300 billion could remove some $6 trillion of lending from the economy almost guaranteeing a hefty recession. According to the federal reserve's October senior loan officer survey, commercial banks tightened up their lending standards, especially for non-conforming residential mortgage loans, but also for most other consumer loans, commercial mortgage loans, and commercial and industrial loans. Bruce Mason is the chief economist at Union State Bank, Orangeburg, N.Y.