zz Recession 2008: How bad it can get

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Recession 2008: How bad it can get

Many
economists are predicting a short, shallow recession. But there's also
a significant risk of a more serious economic decline.

http://money.cnn.com/2008/01/23/news/economy/how_bad/index.htm

By Chris Isidore, CNNMoney.com senior writer

January 23 2008: 3:49 PM EST

NEW YORK (CNNMoney.com) -- The sputtering U.S. economy has gotten
everyone from the financial markets to the Federal Reserve to Congress
in a panic.

But here's a disheartening message for those already worried about economic growth -- it could get much worse.

Most
economists who believe a recession is already here or at least near are
looking for a relatively short and mild downturn, perhaps lasting only
two or three quarters.

But many of those same economists say they
also can envision a worse-case scenario where spending by consumers and
businesses falls off sharply, unemployment heads higher than normal
during a typical recession and housing and credit market problems
worsen.

"I can easily imagine [the economy] going into a free
fall," said Dean Baker, the chief economist for the Center for Economic
and Policy Research. "The danger is that housing prices continue to
tumble and accelerate, people's ability to pull out equity will
evaporate, and you'll see a serious downturn in consumption."

We talked to three more leading economists to find out their biggest economic fears. Here's what they had to say.

Greenback blues David
Wyss, chief economist with Standard & Poor's, said that among his
biggest concerns is that overseas investors could pull back on
investing in the dollar and other U.S. assets.

That could cause
an even greater sense of fear among U.S. consumers and businesses, as
stock prices fall and bond yields rise, which in turn would lift
mortgage rates and be a bigger drag on the already battered housing
market.

"Americans could just get scared by a barrage of bad
news," Wyss said. "The stock market could continue going down because
of foreigners pulling money out, and between that and home values going
through the floor, it could lead to a real pullback of spending,
particularly by Baby Boomers who are getting close to retirement."

Wyss
said he's also concerned that oil prices could shoot higher, even if a
recession cuts into global demand. He said supply disruptions in the
Middle East could send oil prices up to $150 a barrel and help deepen
any recession.

Wyss said that in his worst case scenario, the
unemployment rate would climb to 7.5 percent by early 2009, up from its
current level of 5 percent.

He also believes gross domestic
product, the broad measure of the nation's economic activity, could
wind up as much as 2 percent lower at the end of 2008 than it was at
the end of 2007. That would be the biggest downturn since 1982. Many of
those forecasting a recession this year are expecting GDP to show a
slight gain by the end of the year.

House of pain. Edward
McKelvey, senior economist at Goldman Sachs, agreed with Wyss that, in
a worst case scenario, GDP could fall 2 percent this year..

His
biggest fear is that home prices could fall much further in the coming
months. In fact, Goldman and economists at Merrill Lynch have both
predicted that home values could fall another 15 percent, on top of the
10 percent drop from earlier peaks that has already taken place.

McKelvey said further declines could cause much deeper problems for consumers and credit markets.

"One
of the most likely candidates would be credit markets acting more
violently than we thought, a tightening of the supply of credit to
businesses and households," he said when asked what could bring about
his worst case outlook.

"You could also see a more substantial
response by businesses to the downturn through layoffs, cuts in their
spending and business plans," he added.

Bank woes just beginning. Paul
Kasriel, chief economist at Northern Trust, said he thinks there's a
good chance that the economic pullback will be much steeper than now
widely assumed. This weak forecast is based on his belief that the
billions in dollars of writedowns already reported by Merrill Lynch (MER, Fortune 500), Citigroup (C, Fortune 500), JP Morgan Chase (JPM, Fortune 500), Bank of America (BAC, Fortune 500) and other big banks are just the beginning of the problem in the financial sector.

Kasriel
said that if banks have to report more losses due to bad bets on
subprime mortgages, they will be unwilling, or unable, to make large
loans to businesses and consumers.

So even if the Fed keeps
cutting interest rates, the impact of the cuts may be "less potent"
than rate cuts in previous recessions since consumers and businesses
may not be able to borrow enough to keep spending. That could make this
recession more like the one in 1991-92 than the relatively short and
mild recession of 2001.

"Historically, and not surprisingly,
recessions accompanied by declines in consumer spending tend to be more
severe. And people are going to be constrained from spending by the
declines in housing," Kasriel said.

He added that state and
local governments might have to cut back spending as a result of
declining tax revenue. And that would be another sizable blow to the
overall economy.

"People forget about state and local government spending, but it represents 11 percent of GDP," Kasriel said.