Weak GDP raises stakes for Obama, Fed

Los Angeles Times (Link) - Jim Puzzanghera (August 26, 2010)

The widening consensus that the U.S. economy has slowed to a crawl will be hammered home Friday with the government�s expected announcement that the nation�s second-quarter growth was far more anemic than previously estimated.

Many economists believe the Commerce Department will revise its estimate of growth in gross domestic product to 1.3% or lower, down from 2.4% � a dismal performance, especially as the country struggles to rebound from recession.

A bad GDP number would cap a week�s worth of troubling developments in the housing and financial markets, and ratchet up the pressure on President Obama and congressional Democrats heading into November�s midterm elections.

But just as there is widespread agreement that the economy is faltering, there is also a sense that the federal government is running out of options to rebuild momentum.

�Housing is in the tank. Confidence is going down. The stock market is going down. It�s hard to imagine how consumers will spend,� said Sung Won Sohn, an economics professor at Cal State Channel Islands and former chief economist for Wells Fargo.

He put the probability that economic growth will slide back into negative territory � a double-dip recession � at �40% and going up.�

On Thursday, the Dow Jones industrial average closed below the 10,000 benchmark on the heels of worrisome new economic reports.

The government said that while initial unemployment claims last week dipped to to 473,000, from 504,000 the week before, the four-week average still reached its highest point since November. Unemployment was at 9.5% nationally in July and higher in many states, including 14.3% in Nevada, 13.1% in Michigan and 12.3% in California.

And a mortgage trade group said that, while foreclosures overall continued to ebb, more homeowners fell behind on their payments � the second straight quarter in which that has happened. With unemployment still stubbornly high, the data suggest that foreclosures could soon ramp up again.

Those reports followed news earlier in the week that home sales had fallen to their lowest level in more than a decade, despite mortgage interest rates that are at their lowest levels in nearly 40 years.

�All the indicators at the moment are pointing in the wrong direction,� said Bart van Ark, chief economist for the Conference Board, a business research group.

He doesn�t think the nation will dip back into recession, but said the risk of that happening was rising amid continuing high unemployment.

�We are in the slow lane at this moment,� he said. �The risk of things turning wrong and then dropping the economy into recession is significant.�

On Friday, Federal Reserve Chairman Ben S. Bernanke will give his take on the economy at a meeting in Jackson Hole, Wyo., of central bankers, finance ministers, academics and industry executives from around the world.

As a modest recovery apparently took hold early this year, the central bank began pulling back its extraordinary support. But as growth slowed, the Fed began shifting from exit strategy to re-entry.

It said this month that it would resume buying U.S. Treasury bonds to hold down longer-term interest rates. Fed policymakers said they made the move because the recovery �appeared more modest in the near term than had been anticipated.�

But with the Fed�s benchmark short-term interest rate already near zero, it�s policy options are limited, experts said.

For example, the central bank�s purchases of mortgage-backed securities have helped push mortgage rates to record lows, but home sales still cratered after a federal tax credit expired at the end of April.

Among the limited moves Bernanke could take is eliminating the interest rate the Fed pays banks on about $1 trillion in cash reserves, making it more attractive to lend the money, Sohn said. The Fed also could loosen the reins on banks it regulates, also freeing up more money for loans, he said.

The White House will be among those paying close attention to Bernanke�s remarks.

House Minority Leader John A. Boehner (R- Ohio) called this week for Obama to fire his economic team � an unlikely development, especially since the administration has said its efforts to stimulate the economy are responsible for the recovery, fragile as it may be.

But there is also little doubt that Obama views the economy as a political liability. The president interrupted his vacation on Martha�s Vineyard on Wednesday to hold a conference call with the team, including Treasury Secretary Timothy F. Geithner and top economic advisor Larry Summers, to discuss �recent data reports, global markets and economic growth.�

Additional major government help for the economy appears unlikely because the soaring federal budget deficit has raised red flags and Republicans have sharply criticized last year�s $814-billion stimulus legislation.

The Congressional Budget Office reported this week that the stimulus raised the nation�s economic output, or gross domestic product, from April through June, and lowered the unemployment rate by as many as 1.8 percentage points.

But the CBO said the effects of the stimulus on GDP �are expected to gradually diminish during the second half of 2010 and beyond.�

The nation slipped into recession in December 2007, as rising numbers of homeowners defaulted on subprime mortgages and housing prices collapsed. It worsened in 2008, as unemployment climbed, banks suffered huge losses and the nation�s financial markets teetered on the verge of collapse.

The economy began improving last summer but its momentum has slowed. The initial estimate of economic output in the three months ended June 30 was 2.4%, down from 3.7% in the first quarter and 5% in the final three months of last year.

But that second-quarter figure could be cut nearly in half after more analysis of data, such as business inventories and exports. Growth near 1% is �virtually nothing,� Sohn said.

�This is a harbinger of weak economic growth to come for quite some time,� he said. �Right now, it�s hard to see where we will get any sort of strength.�