News Bytes - Recession Could Be Long and Severe

Recession Could Be Long and Severe - Key Reagan Adviser (extracted from MoneyNews.com 23/2/08)

Martin Feldstein, chairman of President Reagan’s Council of Economic Advisers, says that evidence is mounting that a recession began in December or January.

And unlike many economists who say any recession will be mild and brief, the Harvard economist wrote that there is a good chance it will be long and severe.

That’s largely because Federal Reserve interest-rate cuts are having little effect, he argued this week in The Wall Street Journal. "If a recession does occur, it could last longer and be more painful than the past several downturns because of differences in its origin and character,” Feldstein wrote.

The recessions of 1990-91 and 2001 lasted only eight months, and even the deeper recession of 1981 was over in 16 months.

"But these past recessions were caused by deliberate Federal Reserve policy aimed at reversing a rise in inflation,” Feldstein wrote.

"A key cause of the present slowdown and potential recession was not a tightening of monetary policy, but the bursting of the house-price bubble after six years of exceptionally rapid increases,” he wrote.

"The principle cause for concern today is the paralysis of the credit markets,” Feldstein wrote.
"Credit is always key to the expansion of the economy. The collapse of confidence in credit markets is now preventing that necessary extension of credit.”

It’s not just banks that are cutting back on extending credit, Feldstein notes. It’s also bond markets, hedge funds, insurance companies and mutual funds.

"Securitization, leveraged buyouts and credit insurance have also atrophied,” Feldstein wrote.
As a result Fed rate cuts just can’t jumpstart the economy like they have in the past. "Monetary policy may simply lack traction in the current credit environment,” according to Feldstein.

The situation has turned into a vicious cycle.
"The lack of confidence in asset prices also translates into a lack of confidence in the creditworthiness of other financial institutions, impeding the extension of credit to those institutions,” according to Feldstein.

"And because financial institutions do not even have confidence in the value of their own capital and in the potential availability of liquidity, they are reluctant to make new lending commitments,” he wrote.