U.S. applies medicine as economic ills mount

updated 5:58 a.m. ET Nov. 26, 2008

WASHINGTON - With the economy showing further signs that it is headed into a steep swoon, Treasury Secretary Henry Paulson is pulling more tricks out of his bag to try bolster the country's battered financial sector.

The administration and the Federal Reserve rolled out two new programs Tuesday that would provide up to $800 billion in an effort to get more loans flowing in such critical areas as mortgage lending, credit cards, auto loans and small business loans.

Credit markets liked the new efforts, but private economists said the new moves were not likely to be the last changes in the government's vast rescue program, which has already undergone significant alterations since it was passed by Congress on Oct. 3.

Analysts believe more work will need to be done because of their expectations that the economy's vital signs will continue to worsen as the country slips into what many believe could be the worst recession since the early 1980s.

New data
More news on economic performance will be revealed Wednesday with release of data on personal spending, orders to factories for big-ticket durable goods, new home sales and weekly applications for unemployment benefits.

The report on jobless claims is expected to show that applications for benefits fell slightly last week to 537,000, according to a survey of economists by Thomson Reuters. That would be down by 5,000 from the previous week when claims hit 542,000, the highest level for weekly claims since July 1992. Even with the tiny drop, analysts said claims remain at levels indicating severe stress on the labor market.

The unemployment rate has hit a 14-year high of 6.5 percent, putting pressure on personal incomes, with income growth expected to be a modest 0.1 percent for November, according to the Thomson Reuters survey. These Wall Street economists are expecting that consumer spending plunged by 0.9 percent in October, a dismal showing that would follow a period of extended weakness.

The government reported Tuesday that the overall economy, as measured by the gross domestic product, shrank at an annual rate of 0.5 percent in the July-September quarter, reflecting the fact that consumer spending, which accounts for two-thirds of economic activity, fell at the fastest pace in 28 years.

A weak reading for October would indicate that the current quarter could be off to a rocky start. Nariman Behravesh, an economist at IHS Global Insight, said he was expecting GDP to shrink at a 4 percent rate in the current quarter, reflecting the battering consumers are taking from the worst financial crisis since the 1930s. He predicted that the economy would remain in recession through the first half of next year.

"We are in the early stages of one of the worst recessions in the postwar period, even factoring in a massive stimulus program," Behravesh.

The other reports due out Wednesday were also expected to show further October weakness with orders to factories for big-ticket durable goods plunging by 3 percent and sales of new homes falling by 3 percent, according to the Thomson Reuters survey.

To revive the economy, President-elect Barack Obama has said a top priority will be working with Congress to enact a stimulus package with the goal of creating 2.5 million new jobs over the next two years. Analysts believe such an effort will require spending between $500 billion to $700 billion, a figure that would be on top of all the money being spent to stabilize the financial system.

In the latest efforts to stabilize the financial system, the Federal Reserve announced Tuesday that it will buy $200 billion in securities backed by different types of debt including credit card loans, auto loans, student loans and loans to small businesses. That market essentially froze in October. These types of loans as a result have become harder to obtain and have carried higher interest rates

The Fed also announced that it will spend $500 billion to buy mortgage-backed securities guaranteed by mortgage giants Fannie Mae and Freddie Mac and another $100 billion to directly purchase mortgages held by Fannie, Freddie and the Federal Home Loan Banks.

Mortgage rates to drop?
This would greatly expand an initial modest effort announced in September with the goal of creating increased demand for mortgage-related assets. The hope is that this will drive down the price of mortgages and make home loans more available.

Analysts predict the Fed program could send mortgage rates down by as much as one-half to a full percentage point in coming months, helping to spur demand in the beleaguered housing market, which is suffering its worst downturn in decades.

The latest federal moves raised U.S. commitments to contain the financial crisis to nearly $7 trillion — though no one thinks the government will actually spend anything like that figure.

In the case of the Federal Reserve, the amount covers huge loans that financial institutions will have to pay back. In the case of the Treasury rescue effort, the government will at some point sell the stock it owns back to the banks, presumably when the banking system is doing better and the stock will be worth more.

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