Bruised economy likely to limp into next year

[October 20, 2008]  WASHINGTON (AP) -- Beaten down by housing, credit and financial crises, the bruised economy is likely to drag into next year, leaving more people out of work and more businesses wary of making big investments.

Federal Reserve Chairman Ben Bernanke, scheduled to appear Monday before the House Budget Committee, is likely to once again put the country on notice that there won't be a quick fix.

Even if the turmoil gripping Wall Street were to let up and badly shaken confidence in the banking system fully restored, a "broader economic recovery will not happen right away," Bernanke warned last week. "Economic activity will fall short of potential for a time," he said.

The Fed chief has left the door open for further interest rate reductions to provide some relief.

Dropping rates might induce consumers and businesses to stop burrowing and instead boost their spending, an important ingredient to energize overall economic activity.

So far, though, a string of drastic actions by the Federal Reserve and the Bush administration has yet to turn around a bunker mentality. Banks are fearful of lending money to each other and to their customers. Businesses are reluctant to hire and boost capital investments. Consumers have hunkered down. All the economy's problems are feeding off each other, creating a vicious cycle that Washington policymakers are finding difficult to break.

President Bush has repeatedly asked Americans to be patient and give the government's relief efforts time to work. Democrats on Capitol Hill, however, insist another round of economic stimulus is needed.

Unemployment could hit 7.5 percent or higher by next year. Many analysts predict the economy will shrink later this year and early next year, meeting the classic definition of a recession. Some believe the economy already jolted into reverse during the July-to-September quarter.

One of the president's chief economic advisers said Sunday that parts of the country probably already are experiencing a recession, and it could take a few months before the clogged credit system starts working again.

Speaking in a broadcast interview from California, the chairman of the White House Council of Economic Advisers noted that national unemployment stands at 6.1 percent. Ed Lazear said some areas of the U.S., such as California, have even higher rates of people out of work. "We are seeing what I think anyone would characterize as a recession in certain parts of the country," Lazear said.

Americans are feeling strained as their paychecks shrink and their savings shrivel. That's causing consumers to cut back, one of the reasons the economy is losing traction. Economic slowdowns overseas, meanwhile, are expected to crimp demand for U.S. exports, which had buoyed up the economy.

Last week, the Treasury Department announced it would inject up to $250 billion in U.S. banks in return for partial ownership, something that hasn't been done since the Great Depression. The government hopes banks will use the capital infusions to rebuild their reserves and bolster lending to customers.

"We took this measure as a last resort," Bush said last week. "Had the government not acted, the hole in our financial system would have grown larger," he warned.

So far this year, 15 banks have failed, compared with three last year. And Wall Street's five biggest investment firms were swallowed by other companies, filed bankruptcy or converted themselves into commercial banks to weather the financial storm.

In other efforts to stem the crisis, the Federal Deposit Insurance Corp. is temporarily guaranteeing new issues of bank debt -- fully protecting the money even if the institution fails.

The FDIC also said it would provide unlimited deposit insurance for non-interest bearing accounts, which small businesses often use to cover payrolls and other expenses. Frequently, these accounts exceed the current $250,000 insurance limit, so the expanded insurance should discourage nervous companies from pulling their money out.

The Fed and the world's other major central banks recently joined forces to slice interest rates, the first coordinated action of that kind in the Fed's history. The United States and other top economic powers also have adopted a five-point action plan and pledge to do all they can to provide relief.

Bush plans to host an international summit to discuss ways to fix the world financial system but warned on Saturday against changes that threaten capitalism. Bush, meeting with French President Nicolas Sarkozy and European Commission President Jose Manuel Barroso at Camp David, did not announce a date or site for the summit. But Sarkozy suggested it be held in the shadow of Wall Street before the end of November.

[Associated Press; By JEANNINE AVERSA]

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