Will bank bailout revive growth?

Banks will still need to recapitalize and start lending again.

By Ron Scherer | Staff writer of The Christian Science Monitor

from the September 29, 2008 edition

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New York - Now that Congress appears poised to sign off on a rescue plan for Wall Street, will that save the United States from an economic downturn?

Many economists think not. Even before lawmakers announced a tentative bailout deal early Sunday, the data were showing declines in business spending, a hunkered-down consumer, and rising unemployment. The US economy is, by most indications, on the leading edge of a recession.

The biggest challenge to the economy remains the tight credit markets, which squeezed shut even more Friday after the collapse of Washington Mutual (WaMu), the largest bank to fail in US history. That left economists buzzing about an economic downturn that might be more severe than anything since the Great Depression of the 1930s – especially if Congress punted on the $700 billion rescue plan.

In the absence of a rescue deal for banks and other financial institutions, "we were going to have an extended recession with ... the potential for a depression," says Eugenio Aleman, an economist at Wells Fargo Banks in Minneapolis. "Even with the passage of the rescue plan, the slowdown is going to be long."

One major reason for a continued malaise is that it will take time for troubled banks to recapitalize, even if they unload bad loans on the US government.

"Unless the banks get new capital injections from the private sector, it will be very difficult for them to go out and lend" to businesses and consumers, says Mr. Aleman. If loans are not available for businesses to invest in themselves and for people to buy homes and cars and college educations, the economy as a whole can't grow.

J.P. Morgan Chase & Co., which late Thursday said it would acquire parts of WaMu from the government for $1.9 billion, did manage immediately to raise $10 billion from investors to replenish its capital base. J.P. Morgan said it will write off some $31 billion in bad WaMu real estate loans.

Most banks, however, won't be able to raise money so quickly, says Aleman. "It will take two, three, four years," he says. "But it will be easier to do it if they can get the bad loans off the balance sheet."

Some economists now expect the economic slowdown to continue into 2009. "The problems in the credit market will stretch this out," says Gregory Miller, chief economist at SunTrust Banks in Atlanta.

He anticipates that the downturn will last until April or May. "And, once we recover, it will be modest," he adds. "If I am wrong, it could last longer."

In fact, uncertainty surrounds the government plan as well as the economic forecast.

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