Economic outlook dims sharply

A slump seems inevitable, many experts now say. But they differ on its duration.

from the January 24, 2008 edition

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As happens with all downturns, economists anticipate the unemployment rate will rise, probably throughout the year since business is often late in responding to changes in the economy. On Wednesday, Citigroup economist Steven Wieting cut his estimate for economic growth from 2.4 percent to 1.2 percent and projected unemployment would rise from its current level of 5 percent to 6 percent. This would imply a loss of about 2.5 million jobs.

Mr. Wieting currently expects the slump to be "mild but prolonged," not "quick and deep."

One of the reasons for a longer growth hiatus is that consumers will not be able to use their homes to get access to debt, says Michael Barron, CEO of Knott Capital, an investment advisory firm in Exton, Pa. "Consumers have been able to inflate their balance sheets with rising home prices."

On Tuesday, economist David Rosenberg of Merrill Lynch projected housing prices would fall 15 percent in 2008 and another 10 percent in 2009. In a draconian forecast, he sees housing starts falling another 30 percent to a low not seen since 1982. He says the decline will be necessary to clear record inventories.

With home prices flat or falling, it will be harder for consumers to buy boats, cars, and appliances, he argues. "There will be no pent-up demand, which normally helps lift us out of economic weakness," says Mr. Barron.

Barron also says the economy has changed because the banking system has tightened its lending standards. "Money is available, but the banks don't have to lend it," he says. "It is not that the demand is not there, but there is a higher scrutiny."

Baumohl says the key to recovery will be how fast the financial sector can strengthen its balance sheet. In recent weeks, financial institutions from Bank of America to Citigroup to Merrill Lynch have written off billions of dollars in loans.

"We have rarely had a recession where the financial sector is in such trouble," he says.

The problems in the financial sector are the main reason that economist Gregory Miller of SunTrust Banks in Atlanta says the economy won't recover until the first half of 2009. "We are in a situation where the interest rates are falling but they don't generate much activity," he says. "Banks are very reluctant to add new assets to their balance sheets when they are still uncertain about the value of the loans they have on their books already."

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