WARNING SIGNS: U.S. economy teeters on the brink


Richard Moore

"You know central bankers are concerned about the economy when they condone 
stimulative fiscal policy," BMO Nesbitt Burns economist Michael Gregory remarked
in a note to clients.


U.S. economy teeters on the brink

Bush, Bernanke endorse $100-billion package in effort to prevent recession as 
housing mess hammers banks, consumers and investors

January 18, 2008

WASHINGTON -- In a bid to save the world's largest economy from recession, U.S. 
President George W. Bush and central bank chief Ben Bernanke yesterday endorsed 
a $100-billion stimulus package as the spreading housing mess continued to 
hammer banks, consumers and investors.

The rare plug for fiscal action comes as a growing number of economists say the 
United States is either in recession or perilously close to it. "The United 
States has now effectively entered into a serious and painful recession," said 
economist Nouriel Roubini of New York University.

Prof. Roubini said all of the keys to economic health are headed in the wrong 
direction, including the housing market, credit availability, the job market and
business spending. Add to that a run-up in oil and gas prices, and the consumer 
is likely to take it on the chin in 2008, he said.

Another major Wall Street investment bank acknowledged yesterday that it vastly 
underestimated the cost of its misadventures in the subprime mortgage market. 
Merrill Lynch & Co. - the world's largest stockbroker and one of the major 
backers of mortgage bonds - reported the worst quarter in its history, losing 
$9.8-billion (U.S.) in the final three months of last year and wiping more than 
$16-billion worth of bad loans off its books. That raises Merrill's 
housing-related losses to nearly $24-billion in 2007.

And the U.S. housing slump apparently isn't over. Builders broke ground on new 
homes at an annual rate of a million homes in December - the lowest level since 
1991 and a 14.2-per-cent drop from November, according to U.S. data released 

Since the start of the year, a sense of gloom has taken hold on Wall Street amid
worries that the housing slump is infecting the broader economy. In the past 
couple of weeks alone, stocks have quickly shed virtually all of last year's 
gains. Spooked by the hefty Merrill Lynch loss, investors sent the blue-chip Dow
Jones industrial average down 306.95, or 2.46 per cent, to finish the day at 

The S&P/TSX fell 279 points, after dropping 232 points on Wednesday and 382 on 

It is typically difficult to determine whether an economy is in recession - 
generally defined as two consecutive quarters of shrinking economic activity - 
until it's almost over.

The latest figures show that the U.S. economy, like the Canadian economy, was 
still growing as 2007 ended.

A U.S. recession would have serious consequences for Canada, which sends the 
bulk of its exports south of the border.

Testifying before a U.S. congressional committee, Mr. Bernanke said that a 
proposed stimulus package of $100-billion or more would provide a "significant" 
and "measurable" lift to the economy.

The key, he told the House budget committee, is to put "money into the hands of 
households and firms in the short term" and make the measures temporary so they 
don't compound the government's already significant fiscal problems. That means 
giving consumers and businesses a break this year, he said.

Without endorsing any particular measure, Mr. Bernanke agreed that targeted tax 
cuts or spending would bolster the U.S. Federal Reserve Board's efforts to stoke
the economy with lower interest rates. The Fed has cut its key interest rate by 
a full percentage point since the summer, and many analysts expect another half-
percentage-point reduction at the bank's next meeting on Jan. 30.

"Fiscal action could be helpful in principle" and may provide "broader support 
for the economy," he said.

Mr. Bush also agreed that the weakening economy could use a boost.

White House spokesman Tony Fratto said the President has begun talks with 
congressional leaders on what the plan might look like.

Economist Alec Phillips of Goldman Sachs said Mr. Bernanke's endorsement has 
raised the likelihood that Congress will act soon. "There is enough momentum 
behind it that a deal looks more likely than not," Mr. Phillips said.

But he cautioned that differences between Democrats and Republicans in Congress 
could stall or delay fiscal measures. He pointed out that Congress took four 
months to pass a stimulus package after the 2001 terrorist attacks.

"You know central bankers are concerned about the economy when they condone 
stimulative fiscal policy," BMO Nesbitt Burns economist Michael Gregory remarked
in a note to clients.

Among the measures on the table: a $600 per household tax rebate, an extension 
of unemployment benefits by up to 26 weeks, a targeted housing tax break, a 
research tax credit and an instant tax break for businesses.

Mortgage losses have left several major Wall Street brokers scrambling to shore 
up their finances with cash infusions from Middle Eastern and Asian investors. 
Merrill Lynch, for example, raised $6.6-billion this week by selling preferred 
shares to the Kuwait Investment Authority, a Japanese bank and other investors -
part of a $40-billion Wall Street fire sale triggered by mortgage losses.

Merrill Lynch, Citibank, Bear Stearns and others were part of a once-lucrative 
business of packaging high-risk mortgages into bonds. But as U.S. house prices 
tumbled and teaser introductory interest rates expired, many borrowers stopped 
paying their mortgages and the value of those bonds collapsed.

The major Wall Street banks have already racked up losses of $100-billion in the
subprime debacle. That's still less than the roughly $170-billion banks lost in 
the savings-and-loans crisis of the 1980s, or the $2-trillion that investors 
lost when the technology bubble burst in 2001.

Some experts have predicted that banks could ultimately write off as much as 
$500-billion in investments.

The toll on household wealth, however, would be much greater. A 10-per-cent 
decline in house prices would wipe out $2-trillion worth of household wealth.

Earlier this week, Citigroup, the world's largest bank, reported a $9.8-billion 
fourth-quarter loss. It also wrote down the value of its mortgage-related 
investments by $18.1-billion.

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