Feldstein Warns of U.S. Recession, Urges Fed Rate Cut (Update1)
By Scott Lanman
Sept. 2 (Bloomberg) — Harvard University economist Martin Feldstein said the U.S. housing slump threatens a broader recession, and the Federal Reserve should lower interest rates.
“The economy could suffer a very serious downturn,” Feldstein, head of the group that charts America’s business cycles, told a Fed conference in Jackson Hole, Wyoming, yesterday. “A sharp reduction in the interest rate, in addition to a vigorous lender-of-last-resort policy, would attenuate that very bad outcome.”
Feldstein made a case for lowering the overnight lending rate between banks to 4.25 percent from 5.25 percent to cushion the economy from the fallout of defaults on subprime mortgages. Chairman Ben S. Bernanke told the same gathering on Aug. 31 that the Fed will do what’s needed to stop the past month’s credit- market rout from ending the six-year expansion.
Lowering interest rates may result in a “stronger economy with higher inflation than the Fed desires,” a situation that Feldstein described as the “lesser of two evils.”
“If that happens, the Fed would have to engineer a longer period of slow growth to bring the inflation rate back to the desired level,” said Feldstein, 67, president of the National Bureau of Economic Research. Some investors speculated that Feldstein was a candidate for Fed chairman before Bernanke was picked to succeed Alan Greenspan.
Bernanke wasn’t in the room for Feldstein’s speech, though most other Fed officials were, along with central bankers and economists from around the world who traveled to the annual mountainside conference hosted by the Kansas City Fed bank.
`Good Judgment’
“Marty is a guy of good judgment,” said former Fed Governor Lyle Gramley, who attended the event. “Everybody in the room recognizes that. Everybody, including the people at the Fed, will think carefully about what he said.”
The U.S. economy expanded at a 4 percent annual rate in the second quarter, the fastest pace in more than a year, before turmoil in the credit markets forced the Fed to warn in an Aug. 17 statement that risks of slower growth had increased “appreciably.”
Already, some indicators are suggesting a weakening economy. First-time applications for jobless benefits rose to the highest level since April in the week ended Aug. 25. Property values in 20 metropolitan areas fell 3.5 percent in June from a year earlier, according to an Aug. 28 report by S&P/Case-Shiller.
The economy was last in recession from March to November 2001, according to NBER.
`Triple Threat’
Feldstein outlined a “triple threat” from housing: a “sharp decline” in home prices and construction; higher borrowing costs and a “freeze” in credit markets stemming from subprime-mortgage losses; and fewer home-equity loans and refinanced mortgages, leading to less consumer spending.
Investors expect the Fed to cut the federal funds rate on overnight loans between banks to 5 percent on Sept. 18 and at least another quarter-point by year’s end. The central bank has left the rate at 5.25 percent since June 2006 after raising it from 1 percent over a two-year period.
Gramley, a senior economic adviser at Stanford Group Co. in Washington, said he was surprised by the gloominess of Feldstein’s 25-minute speech, which capped a conference where many participants were pessimistic.
`Useful Information’
Kansas City Fed President Thomas Hoenig, speaking briefly after Feldstein, said the symposium gave him and probably his colleagues “a lot of useful information to use as we deal with some difficult issues that confront us all.”
Earlier in the day yesterday, Fed Governor Frederic Mishkin presented a paper in which he said that U.S. banks can cope with “stressful” conditions and that the financial system is in “good health” even with the disruptions of the mortgage market.
Mishkin also reiterated that policy makers should avoid setting interest rates according to swings in the housing market and respond “only to the extent that they have foreseeable effects on inflation and employment.” That point was challenged by some participants, including Bank of Israel Governor Stanley Fischer.
Feldstein had said in an interview on Aug. 31 that there is a “significant risk” of a downturn and urged the Fed to cut borrowing costs.
Feldstein is a member of the Business Cycle Dating Committee of the NBER, which like Harvard is located in Cambridge, Massachusetts. The panel includes six other economists and is chaired by Robert Hall, an economist at Stanford University’s Hoover Institution.
To contact the reporter on this story: Scott Lanman in Jackson Hole at slanman@bloomberg.net
Last Updated: September 2, 2007 10:31 EDT
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Bernanke’s Pledge Fails to Dispel Pessimism at Jackson Retreat
By John Fraher and Scott Lanman
Sept. 3 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke’s pledge to stop the credit-market rout from wrecking the economy failed to quell concern at the Fed’s Wyoming summer retreat that the U.S. is heading for recession.
“I came to Jackson Hole thinking there would be no recession, but I’m leaving thinking we could well have one,” said Susan Wachter, a professor at the University of Pennsylvania’s Wharton School, who co-wrote the first academic paper presented at the conference.
This year’s theme — Bernanke said organizers had “outdone themselves” with a relevant topic — was housing and monetary policy, eliciting forecasts of sliding home prices and criticism the Fed should have done more. Martin Feldstein of Harvard University warned of a “very serious downturn” and called on policy makers to cut interest rates by 1 percentage point.
The normally academic tone of the Kansas City Fed’s symposium was replaced this year by concern that the sudden increase in the cost of credit to people and companies will hurt spending and investment. Consumer confidence dropped by the most in two years in August, the Conference Board reported on Aug. 28.
“There are no optimists in the crowd here,” said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York and a former head of domestic research at the New York Fed. “There’s a pretty strong consensus that this has gotten a lot more serious.”
As officials and professors debated lessons from the housing slump, New York Fed President Timothy Geithner and Governor Randall Kroszner were spotted on their mobile phones. Geithner is the central bank’s liaison to Wall Street, while Kroszner heads the Fed board’s banking supervision committee.
`Very Serious’
“The economy could suffer a very serious downturn,” Feldstein, president of the National Bureau of Economic Research in Cambridge, Massachusetts, told the conference. The NBER dates American economic cycles. The last recession was from March to November 2001.
Bernanke, dressed in a dark grey suit that stood out from the typical dress of polo shirts, jeans and khakis at the Grand Tetons gathering, said in the opening speech that the Fed will “act as needed” to protect the expansion.
That didn’t assuage critics such as Edward Leamer, the head of an economic forecasting group at the University of California at Los Angeles. He wrote in one of the conference papers that the Fed merited an `F’ for failing to prevent the housing bubble and then not reducing rates as it burst.
`Lesser of Two Evils’
Feldstein called for “a major reduction now in the federal funds rate, possibly by as much as” 1 percentage point from the current level of 5.25 percent. While that may push up inflation, it’s the “lesser of two evils,” he said in a Sept. 1 speech.
Fed policy makers next meet on Sept. 18. While central banks pumped $350 billion in emergency funds into money markets last month, signs of stress continue.
Commercial paper, a short-term financing tool, declined by $244.1 billion, or 11 percent, in the three weeks to Aug. 29, the most in at least seven years, Fed data show. Three-month Treasury bill yields had their biggest drop since 2001 in August as investors sought safety in government debt.
Delinquencies on subprime mortgages, the origin of the turmoil, are likely to climb further as variable-rate loans reset higher, Bernanke said.
Even so, “global financial losses have far exceeded even the most pessimistic projections of credit losses on those loans,” he said. That’s because of difficulties in setting prices for complex securities and concerns that housing will hold back economic growth, the Fed chief said.
`Gloomy as I’
“I rather expected that I would come out and find that people weren’t quite as gloomy as I was, and I didn’t find that,” said former Fed Governor Lyle Gramley, now a senior economic adviser at Stanford Group Co. in Washington. “So it confirmed my own concerns about the economy.”
Attendees nevertheless sounded confident that the global economy, which has relied on the U.S. to drive growth for much of the past decade, is strong enough to cope with the slowdown.
In China, where the economy expanded at the fastest pace in more than 12 years in the second quarter, manufacturing unexpectedly quickened in August. While business confidence in Germany, Europe’s largest economy, fell last month, it was still better than most economists had forecast.
“The world economy is still very robust and growth is much more evenly spread than it was a few years ago,” Otmar Issing, former chief economist at the European Central Bank, said in an interview.
That was little comfort to most at the conference as they debated the impact of the housing recession on consumer spending, in between hikes along trails near Yellowstone Park.
Yale University professor Robert Shiller said house prices in some U.S. cities may fall by as much as half, while Leamer predicted declines in some areas of 30 percent to 40 percent. Feldstein saw the chance of a “substantial decline” in spending because consumers won’t be able to borrow as much against the value of their homes.
To contact the reporters on this story: John Fraher in Jackson Hole, Wyoming at jfraher@bloomberg.net , Scott Lanman in Jackson Hole, Wyoming, at slanman@bloomberg.net
Last Updated: September 3, 2007 00:01 EDT
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