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Woes deepen for U.S. economy

Bush says banking system 'basically sound,' but his team urges federal intervention.

By Staff writer of The Christian Science Monitor / July 16, 2008

SOURCES: Bureau of Labor Statistics, Census Bureau, Yahoo! Finance, Conference Board/© 2008 MCT

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Expectations that the current US economic downturn will be shallow are diminishing.

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A severe recession in the United States still isn't the mainstream forecast, but economists say it's a real possibility, especially as problems at American banks deepen amid a continuing shakeout of the housing crisis.

What makes forecasts challenging these days is that the economy's problems involve the linkage of many moving parts. Crucially, a healthy banking system is vital to the economy, and now an economic slowdown and a plunge in bank stocks have raised the prospect of more bank failures and the need for federal intervention.

The rising uncertainty and risk were visible Tuesday, from auto manufacturing to the value of the dollar. General Motors canceled dividends for shareholders, something it hasn't done since 1922. The dollar fell to a new low against the euro. Stocks fell worldwide.

Everyone from CEOs to policymakers to ordinary investors and depositors are grappling with the question: How bad is this crisis? How bad could it get?

It's a sign of the times that Federal Reserve Chairman Ben Bernanke, the closest thing to a spokesman for the economy, talked a lot about unknowns even as he sought to reassure lawmakers Tuesday at a congressional hearing. One major question, he said, is how long housing-market declines will persist.

"It's that uncertainty, I think, that is generating a lot of the stress … that we're seeing," he said in response to questioning.

As of June, the Fed's policymaking committee gauged the economy's path looking forward as "below its trend rate" – not necessarily in recession but well below normal growth of 3 percent or so, Mr. Bernanke said.

However, the central bank believes any surprises are more likely to be on the side of weakness, not strength, he said.

While citing an "unusually uncertain" outlook for whether inflation will come back under control, the Fed chairman laid down a marker on another top concern. "Helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve," he said in his prepared statement.

In fact, the Fed was created in 1913 with the goal of preventing and mitigating banking crises.

"The lifeblood of a modern economy is credit," says Ken Goldstein, an economist at the Conference Board, a business research group in New York. "Inability of [mortgage firms] Fannie Mae and Freddie Mac to raise capital could potentially bring them down…. It's exactly why [Treasury Secretary Henry] Paulson and Bernanke have been and are so willing to take extraordinary steps."

For his part, Mr. Goldstein predicts that the economy will escape a steep downturn as it has done over the past year of turmoil, thanks in part to US policy moves.

But those moves are becoming, to use his word, extraordinary.

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