Expect U.S. economic woes to linger into 2009

The financial troubles in the United States are far from over. The economic downturn, probably already a recession, could last deep into 2009, with rising unemployment and continuing business failures.

That's the view of several economists.

"This is not like credit crunches of the past," notes Washington consulting economist Harald Malmgren, in an e-mail from Tokyo. "What we are going through is a gradual, painful credit contraction, as lenders try to gather new capital and reduce their [loans]."

Milton Ezrati is less pessimistic. "The worst is done," says Dr. Ezrati, a senior economist of Lord Abbett & Co., a mutual fund company in Jersey City, N.J. But he also expects subpar economic growth "well into 2009" as financial institutions continue to writeoff weakened assets and consumers restrain expenditures after "a debt binge for 20 years."

Henry Kaufman, a veteran Wall Street economist dubbed "Dr. Doom" in the 1960s, figures the mess in securitized assets, such as those loaded with sub-prime mortgages, is "60 to 65 percent over." But because banks and other financial institutions will extend less credit, the economy will "scoot along at close to recession levels" for the next couple of years, he says.

The economy has already been in a recession since early this year, maintains Allen Sinai, top economist at Decision Economics in Waltham, Mass. The credit crunch will last "at least another year."

Paul Kasriel, an economist at Northern Trust Co. in Chicago, predicts a "very mild recovery" from recession in the first half of 2009. Meanwhile, financial institutions will be dealing with more losses in credit-card debts, auto loans, and commercial real estate loans. Corporate profits, outside the energy sector, will be weak. The high-yield corporate bond market (junk bonds) will be troubled by more failures. Many consumers will face tighter limits on credit-card debt and on home equity loans.

It's not a pretty picture.

In a way, all of these problems can be blamed on dishonesty.

"Greed was the underlying factor," writes Russell Palmer, CEO of a private investment group in Philadelphia and a former dean of the University of Pennsylvania's Wharton School. "Wall Street hedge funds and others are looking for any financial machination that they can find to hype their financial returns. The whole mortgage fiasco is just the latest example."

In an online article for the business school, Mr. Palmer states: "Something as important as our system for financial transactions and our economy has to be built on integrity and trust as opposed to questionable and disreputable activities."

What is needed, he argues, is better leadership and oversight that will not ignore the high risks involved in some financial products.

Mr. Malmgren notes that the trust necessary to the working of Wall Street has broken down. Banks and brokerage firms do not trust one another. They hesitate to buy into new or old securities that include undefined mortgages, business loans, credit-card loans, or other assets as their base.

"We have to get private markets working again," says John Coffee, a finance professor at Columbia University in New York. Wall Street has not responded adequately to revive the process of "securitization," where banks and other financial institutions package a bunch of loans, such as mortgages, into a security that can be sold to investors.

Professor Coffee is concerned that the housing market is becoming too dependent on "dangerously overextended" government-backed entities such as Fannie Mae, Freddie Mac, and the Federal Housing Administration. He wonders if the federal government will end up with a huge bill for failed mortgages. Without private buyers of home mortgages, the housing market will not revive sufficiently to give the economy a good boost, he maintains.

Given Wall Street's failure to adequately supervise its own institutions, Washington is stepping in with a debate over how to better regulate the financial industry. Last Tuesday, for instance, the Securities and Exchange Commission announced "an ambitious effort" to review the system of disclosure of information about public firms, mutual funds, brokers, and other regulated entities.

The Treasury proposed in March a huge array of regulatory reforms "in a genuine and correct belief that financial market innovation has made obsolete most of the existing array of regulatory agencies and laws," as Malmgren puts it.

Dr. Kaufman suggests creation of a new "Federal Financial Oversight Authority" to supervise the nation's 15 largest financial institutions. They have a total of $13 trillion in assets. It would exist under the auspices of the Fed and report annually to Congress. One goal would be to assure the soundness of various esoteric financial instruments that these 15 firms put together and sell.

To restore confidence, says Malmgren, a "standardization" of securitized debt is needed so investors know what they are buying, including a detailed description of their content and identification of their originator. That way, the SEC and the courts could better deal with misinformation and deception, that is, Wall Street dishonesty.