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November 26, 2007
'Odds now favor a recession' - Summers
In a grim column appearing in the Financial Times, former Treasury Secretary and Harvard University President Lawrence Summers says that the financial crisis gripping credit markets is only going to get worse:
Even if necessary changes in policy are implemented, the odds now favour a US recession that slows growth significantly on a global basis. Summers also points to a doubling in the rate of foreclosures next year as well as an even more pronounced credit crunch as causes of an economic slowdown that may lead to a prolonged and serious recession.
Without stronger policy responses than have been observed to date, moreover, there is the risk that the adverse impacts will be felt for the rest of this decade and beyond. Several streams of data indicate how much more serious the situation is than was clear a few months ago.
First, forward-looking indicators suggest that the housing sector may be in free-fall from what felt like the basement levels of a few months ago. Single family home construction may be down over the next year by as much as half from previous peak levels. There are forecasts implied by at least one property derivatives market indicating that nationwide house prices could fall from their previous peaks by as much as 25 per cent over the next several years.
We do not have comparable experiences on which to base predictions about what this will mean for the overall economy, but it is hard to believe declines of anything like this magnitude will not lead to a dramatic slowing in the consumer spending that has driven the economy in recent years.
Summers recommends swift action by the Fed as well as maintaining the flow of credit through so-called "super conduits" - groupings of banks who assume the debts of lending institutions that need it.
The former Secretary of the Treasury certainly paints a grim picture of our immediate economic future. The question, as always, is how much intervention by the Fed is necessary or desirable? The Fed weilds a huge stick and no one doubts its ability to maintain liquidity in the credit markets. But by doing so, the governors risk letting the inflation genie out of the bottle - something that would do more damage in the long term than any short term fixes.