Wash. Post: Signs Are Pointing South on Wall St.


Richard Moore

       "The Federal Reserve Bank of New York said it would make at
        least $8 billion available so banks do not find themselves
        short of cash through early January. Former Treasury
        secretary Lawrence Summers said in a column in yesterday's
        Financial Times that he now believes the odds favor a
        recession, a view he did not hold a few weeks ago."

Notice how the Federal Reserve, a private for-profit company, can play this game
out however it sees fit.


Original source URL:

Signs Are Pointing South on Wall St.
Credit Woes Foster Bets on Bad Times
By Neil Irwin
Washington Post Staff Writer
Tuesday, November 27, 2007; Page A01

Wall Street is betting on a recession.

Investors in stocks and bonds are paying prices that indicate they believe a 
snowballing housing crisis and worsening credit crunch will soon tip the U.S. 
economy into a recession, analysts said. Many economists, including leaders of 
the Federal Reserve, don't think things will get that bad, but some say the risk
of a serious downturn has risen in recent weeks.

Investors were so eager to buy ultra-safe government bonds yesterday that they 
were willing to accept sharply lower interest rates. The rate on the 10-year 
Treasury bond fell to 3.84 percent from 4 percent Friday. The low rates indicate
investors expect the Federal Reserve to cut interest rates aggressively in the 
coming year to ease the pain of recession.

Stocks are now down more than 10 percent from their peak in October. The 
Standard & Poor's 500-stock index fell 2.3 percent yesterday, dropping the 
market to a level that Wall Street analysts say reflects an expectation that 
corporate profits will fall.

Taken together, those and other data indicate that financial markets have a 
decidedly negative prognosis for the economy. "They're saying the odds of a 
recession are pretty damn high," said Diane Swonk, chief economist at Mesirow 

There are reasons to think things will not get that bad, however. Holiday sales 
started Friday with a strong 8.3 percent gain over last year, and U.S. consumers
have proven resilient in past periods of financial distress. With the dollar 
weakening, U.S. exporters will be at an advantage; joblessness remains near 
historic lows, at 4.7 percent; and the stock market, an old joke goes, has 
predicted nine of the past five recessions.

Moreover, economic growth could slow sharply through the first half of next 
year, as the Federal Reserve and myriad private firms predict, without 
technically falling into recession territory. A recession is defined as a 
significant decline in economic activity, as measured by a variety of 
indicators, that lasts more than a few months. The nonprofit Conference Board 
said yesterday that its index of leading economic indicators fell in October, 
but not by so much as to suggest a recession is about to begin.

Other events yesterday showed how widely worry has spread.

The Federal Reserve Bank of New York said it would make at least $8 billion 
available so banks do not find themselves short of cash through early January. 
Former Treasury secretary Lawrence Summers said in a column in yesterday's 
Financial Times that he now believes the odds favor a recession, a view he did 
not hold a few weeks ago.

Housing prices are falling sharply in many of the nation's biggest cities, and 
millions of foreclosures are forecast for the next two years. Oil prices are 
near $100 per barrel, which could thin out consumers' pocketbooks if the winter 
is especially cold. And as the value of the dollar drops, imports as varied as 
French wine and Japanese electronics could become more expensive.

In a view increasingly typical among Wall Street economists, analysts at Merrill
Lynch published a research note yesterday with the headline: "We believe we are 
going to see a recession in '08."

Widespread expectations of a recession could be self-fulfilling because of how 
financial markets and mainstream America are interconnected. If investors are 
sufficiently convinced a recession is ahead, they would be reluctant to lend 
money to businesses that want to expand, making it so.

Just a month ago, financial markets seemed to be healing from the tumult of the 
summer, when fear of losses in the mortgage sector caused many markets to 
effectively shut down. But throughout November, the very institutions that were 
expected to ease the blow to the economy have shown more evidence of trouble.

Investors are worried that major banks are suffering such severe losses from 
mortgage and other risky securities that they will not be able to lend as much 
money to consumers and businesses in the months ahead. The same fears apply to 
Fannie Mae and Freddie Mac, the government-sponsored housing finance companies.

"It looked like the problems in the credit markets were going away or at least 
calming down a few weeks ago," said David A. Wyss, chief economist of Standard &
Poor's. "Now the signs are that they're not."

The credit problems are no abstraction. They make it more expensive for 
individuals to obtain mortgages and for businesses to expand.

Higher interest rates for risky mortgages, for example, could make it difficult 
for would-be buyers to afford a home, which could cause prices to drop further. 
That, in turn, could spur more foreclosures, which could lead financial 
institutions to further increase rates they charge on mortgages.

"These things feed off of each other," Wyss said.

The same is true for businesses. Continuing expansion of the commercial real 
estate sector, for example, including office buildings and shopping centers, has
been a major cushion from the housing downturn in recent months and has kept 
construction workers employed.

In February, owners could borrow against such properties at interest rates about
one percentage point above the rate for Treasury bonds, based on a Morgan 
Stanley index for moderately risky commercial mortgage-backed securities. At the
end of September, commercial property owners had to pay an additional four 
percentage points. By yesterday, the premium was seven percentage points.

Higher borrowing costs could make commercial builders less likely to move 
forward with new construction, analysts said, eliminating a crucial source of 
growth in jobs and in the gross domestic product.

The potential freeze in bank lending could mirror the savings and loan crisis of
the early 1990s, a major cause of the 1990-91 recession.

"In any recession, you get to a tipping point where sentiment unravels and feeds
on itself. Psychology takes over," said Mark Zandi, chief economist of Moody's 

Staff writer David Cho contributed to this report.

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