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| Bernanke: He testified before Congress Wednesday. Jonathan Ernst/Reuters |
Some signs of optimism on economy
Banks raise capital; senators look at a bipartisan mortgage-rescue package.
from the April 3, 2008 edition
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"There's a real danger of a very sharp contraction in the economy where many jobs will be lost," says Charles McMillion, an economist at MBG Information Services in Washington.
This leaves the Federal Reserve in a difficult position. Lawmakers on Wednesday asked Bernanke whether interest-rate cuts will fan inflation. But they also questioned the wisdom of recent creative moves by the Fed to maintain stability in the banking system – notably its rescue of investment bank Bear Stearns by putting $29 billion of Fed resources on the line.
In this climate, the way forward can seem fraught with difficulties on all fronts. Is optimism justified?
"Both the hope and panic are overblown," says Mr. Goldstein in New York.
It's too soon to say the problems are fading, he explains. But a catastrophic outcome is unlikely, he says.
In the banking sector, losses are large but not necessarily unmanageable. Mortgage-related write-downs may end up totaling $500 billion, and losses on credit cards, industrial loans, and other debts could double that figure, economists at Goldman Sachs estimate.
But because so many debts are packaged for resale to investors, only about half of those losses fall directly on firms such as commercial and investment banks, they reckon. Those firms have recently raised about $100 billion in new capital. The moves by firms such as UBS this week add to that total.
"That was in fact very encouraging," Bernanke said during the hearing.
In the real estate market, prices may have further to fall. Yet both ordinary buyers and investment firms are waiting on the sidelines for now, ready to jump in at some point.
"That line [of potential buyers] has been building for a year and half, and it's going to get longer," says Goldstein. That should build a floor under home prices.
Congress ready to act
Legislation in Congress could also help.
Spending taxpayer money to try to prevent foreclosures is controversial, both among economists and ordinary Americans.
Opponents say the marketplace can best deal with the wave of mortgage defaults. They warn, too, that any bailout will encourage future reckless behavior.
Many proponents say legislation, if it reduces the pace of foreclosures, will help neighborhoods and the whole economy. The legislation now under consideration also attempts to distinguish deserving borrowers from undeserving ones.
The housing slump must ultimately be resolved in the marketplace, Goldstein says. But in his view the measure under review, crafted by Sen. Christopher Dodd (D) of Connecticut, will probably do more good than harm during this time of market stress.
The bill aims to refinance more at-risk borrowers, both by providing money to localities and through Federal Housing Administration loan guarantees.
"If we don't do this … we're going to wind up with more folks that lose their homes," Goldstein says. "It's not just a family that's thrown out in the street. It's not good for that community. And it's no good for the bank."
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