FT.COM: The R-word surfaces on Wall Street

The R-word surfaces on Wall Street
By Eoin Callan in Washington
Published: September 10 2007 03:52 | Last updated: September 10 2007 03:52


The R-word is usually avoided by Wall Street’s economists. It tends to be a conversation-stopper when investment bank clients are told to prepare for the worst.

“It is like looking a client in the eye and telling them that their child is ugly,” says David Rosenberg, chief economist at Merrill Lynch. “It is not what people want to hear.”

But the parameters of polite conversation have shifted following the shock decline in the employment market revealed last week. Recession is the word on everyone’s lips.

“The probability of recession has increased pretty dramatically,” says John Silvia, chief economist at Wachovia. The first monthly fall in employment in four years has undermined one of the few remaining pillars of the economy – a strong job market – that policymakers thought they could rely on to support consumer spending.

With that cornerstone of economic growth weakened, some on Wall Street fear the economy could be dragged into a hole by the gravitational pull of the collapsing housing market.

“You are talking about a $23,000bn asset class – there is nothing on the planet as big as that,” says Mr Rosenberg, who is predicting a fall in house prices nationally of up to 15 to 20 per cent.

The bearish economist points out that “there has never been real estate deflation in this country that failed to end in a destabilising recession”.

He says the historical conditions are falling into place for a deterioration in household wealth and spending by the fourth quarter.

Homebuilding has fallen by a fifth from a year ago to the lowest level in a decade.

Big falls have in the past been followed by recessions, except during the Vietnam and Korean wars, which created offsetting demand.

The housing downturn has caused economic shocks, triggering a crisis of confidence in credit markets and a tightening of lending conditions amid rising defaults on subprime mortgages.

Mr Rosenberg says it may be “too late” for the Federal Reserve to prevent a recession by cutting interest rates aggressively this month.

But many economists are more sanguine, reassuring clients that rate cuts will help restore stability to markets and prevent the economy going into a tailspin.

“It is too soon to call a recession at this point,” says Peter Hooper, chief economist at Deutsche Bank. “The risks have been certainly moving in that direction.”

Bruce Kasman, chief economist at JPMorgan, has pared back his forecasts but sees moderate growth averaging about 2 per cent over the next two quarters. But he warns that economists are “making forecasts these days with pencils not pens”.

Edward Lazear, economic adviser to President George W. Bush, says the White House is not expecting a downturn. “There is always a chance of recession. We don’t think it’s likely.”

The job of declaring recessions – generally defined as two consecutive quarters of economic contraction – does not belong to the White House or Wall Street. That task belongs to Martin Feldstein, head of the National Bureau of Economics.

Mr Feldstein has been blunt about his outlook.

He used the word recession seven times in a recent speech to central bankers, telling them that “a sharp decline in house prices and the related fall in home-building ... could lead to an economy-wide recession”.

He said the type of collapse in housebuilding recorded in recent months was “a precursor to eight of the past 10 recessions”; there was “a significant risk of a very serious downturn”. It was not a popular message.

Copyright The Financial Times Limited 2007