State of the Economy Check In

The country's economic future continues to be a hot topic. Is a recession looming? Mark Zandi, Chief Economist of Moody's Economy.com talks with John Ydstie about how the Federal Reserve is responding and White House attempts to convince lenders to help those with Adjustable Rate Mortgages.

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JOHN YDSTIE, host:

Are recession clouds looming? Federal Reserve Chairman Ben Bernanke indicated as much this week. Speaking in Charlotte, North Carolina, on Thursday night, Mr. Bernanke said the economy faces headwinds, requiring the Fed to be exceptionally alert and flexible. There were also reports this week that the Bush administration is trying to convince mortgage lenders to provide some relief to borrowers who face rising interest rates under adjustable rate mortgages.

Joining us to talk about all of this is Mark Zandi of Moody's Economy.com. Welcome.

Mr. MARK ZANDI (Chief Economist, Moody's Economy.com): It's good to be with you, John.

YDSTIE: First of all, Mark, were you surprised at Bernanke's comments, and do they suggest a recession is more or likely than had been thought?

Mr. ZANDI: Well, thank goodness, he's now sounding an alarm. The economy is struggling; I've been surprised that the Federal Reserve hasn't been more aggressive in their, at least, discussion about the economy's problems, and I do think they're now starting to catch up. The economy is weak, and they recognize that, and they're signaling for the rate cuts, which I think are appropriate.

YDSTIE: Now, the stock market has rallied as the Fed has signaled a willingness to cut rates. Does that suggest the collective vote out there is that there'll be rate cuts, and so we'll avoid a recession?

Mr. ZANDI: Well, there is a resounding vote that we need rate cuts. If we don't get them then a recession would almost assuredly ensue. So I don't think we're out of the woods yet; I don't think the market thinks we're out of the woods yet. But I do think people are relieved that the Federal Reserve now is more aggressive and engaged, and hopefully, we will avoid one.

YDSTIE: Mm-hmm. Do you think it's still possible to avoid one with rate cuts over the next few months?

Mr. ZANDI: Yeah, I think it's possible, sure. We need a little bit of luck when you see oil prices come down; that would be very helpful. Recession risks are very high though. The economy is struggling with a very severe housing downturn, and the global financial system is very unsettled, so the rate cuts may not do it, but they are necessary if we are going to be able to avoid one.

YDSTIE: Let's talk a little bit about that housing crisis. The Bush administration, this week, has been trying to work out with mortgage lenders, including Countrywide and Citibank and others, to get some relief for people with adjustable rate mortgages. Give us your understanding of how that would work.

Mr. ZANDI: Well, the idea is that many new homeowners - folks that got into the subprime loans in the last couple of years - are now facing a payment reset. The resets are very large; most of these homeowners won't be able to make good if they actually have to make the higher mortgage payment go to default and go with the foreclosure. So the idea is that if you have one of these loans, you live in the home, you're still current on the mortgage, you'll be able to keep the current interest rate, and hopefully, in a couple of three years, when the housing market settles and more credit is flowing into the housing market, you'll be able to refinance into another mortgage and stay in the home. So it's an effort to keep people in homes long enough until the housing market settles down.

YDSTIE: Is this simply an effort to help individuals or could this also help avoid a recession?

Mr. ZANDI: Both. Clearly, there are a lot of homeowners who are facing foreclosure - a couple of million in the next year or two. So that's a lot of people; that's a big chunk of population. Certainly in California, Florida, Michigan, this is very important, but it's also important for the economy. I think if we don't do something like this and if we're not successful, then the housing market's going to evaporate, take other parts of the economy with it and we will be in recession even if we get those rate cuts. So I think this is key to continued economic growth in 2008, which, obviously, is very important for folks in Washington as we approach the presidential election.

YDSTIE: What about the banks and their investors? Are they likely to go along with this? They're giving out money; they're - right?

Mr. ZANDI: Well, at the end of the day, they'll probably do better under this plan. These folks aren't going to make good on these mortgages if they have to make these mortgage payment terms. It's just not going to do it, so I do think investors, when it's all said and done, will do better. This is actually implemented then if they don't agree to do it. Now, certain investor groups are probably going to be vehemently opposed to this just because the way these things were structured and that goes to one of the reasons why it's been so hard to get everyone on board with something like this. But I think, in aggregate, I think investors will be better off.

YDSTIE: Mark Zandi of Moody's Economy.com, thank you very much.

Mr. ZANDI: Thank you, John.

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