Analysts Weigh Recession Forecast

Investors are worried about the mounting evidence that the United States is headed for a recession. Many economists say that if a recession comes, it would probably be over quickly. But they say a downturn overseas could prolong it.

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There was a moment when it seemed like people could count on the global economy to prop up the United States. Other nations were booming just as the U.S. was struggling. A quick look at world markets this week suggests that it's hard to count on anything. Asian markets did recover today after two straight days heading downward. It helped that the Federal Reserve cut interest rates. But it is not clear that will be enough. European markets are slipping today.

NPR's Jim Zarroli reports on the economic dangers abroad and at home.

JIM ZARROLI: Carmen Reinhart, an economist at the University of Maryland, studies banking crises. She says they almost always follow the same script. There is a big run-up in the price of some asset like stocks or houses. People see how much money is being made and they want in on it. Foreign investors rush in, people borrow a lot. And then in the heady atmosphere that follows, Reinhart says banks start to relax their lending standards.

Professor CARMEN REINHART (University of Maryland): You start making riskier loans, engaging in riskier projects, and those start to go sour. And that's how the bubble is pricked.

ZARROLI: Reinhart says once banks start losing money, they get scared. They're reluctant to lend. And Reinhart says the subprime mortgage crisis that erupted last year is almost a classic bank crisis. Bank crises can do a lot of damage to the economy. If enough banks stop lending, businesses can no longer get the capital they need to operate. They stop buying things. They lay people off.

Reinhart says a sharp economic slowdown is a veritable certainty this year.

Prof. REINHART: I would be surprised. We would be incredibly lucky if we didn't have one because a lot of wealth is being destroyed.

ZARROLI: This kind of systemic downturn, in which lending activity slows down, is something that scares a lot of economists because it can be hard to shake off. Once confidence erodes in the economy, it can be difficult to restore. That's what happened in Japan in the 1990s when housing and stock prices cratered and no one wanted to invest, even with interest rates near zero.

And Bernard Baumohl of the Economic Outlook Group says the U.S. could face a similar prospect this year.

Mr. BERNARD BAUMOHL (Economic Outlook Group): That's the concern, I think, that everybody has right now, that we're in a recession that could get a lot worse, and that this recession has been induced largely by a deterioration in the financial sector. And when you have that kind of a problem, then it's much more serious than a typical kind of recession.

ZARROLI: And this is happening at a time when the economy is facing other risks already. For instance, one of the real bright spots for U.S. companies right now is exports. Europe, Asia, the Middle East and Latin America are prospering, and with the dollar so weak, people in those places are buying more American-made products. But the turmoil in overseas stock markets this week suggests that those economies could be headed for trouble too. If that happens, the export boom may not last.

Nariman Behravesh is senior economist at Global Insight.

Mr. NARIMAN BEHRAVESH (Economist): Indeed, if growth weakened overseas significantly, then the recession in the U.S. could be deeper and longer.

ZARROLI: But other economists say it's by no means clear how far the subprime damage will spread. For one thing, compared to Japanese central bankers in the 1990s, Federal Reserve officials responded to the crisis pretty quickly - if not quite quickly enough to satisfy some of their critics. They cut interest rates several times, the most recent being the surprise three quarter point reduction yesterday morning. And U.S. officials are discussing measures like tax rebates to stimulate growth.

The University of Maryland's Carmen Reinhart says these efforts should eventually bear fruit.

Prof. REINHART: It doesn't impact what's going to happen today or what's going to happen next week because monetary policy works with a lag, but it's certainly a major step in the right direction.

ZARROLI: Reinhart says the truth is that most bank crises end without doing any significant damage to the economy. But there have been notable exceptions. How much the subprime crisis can be contained is unclear, in part because so much is still unknown. Most banks don't yet have a real grasp of how much they have lost in the mortgage downturn. Until they do, the real impact of the crisis can't be determined.

Jim Zarroli, NPR News, New York.

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