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Economic Forecasts

Recession Talk Is All Wet

The mess in subprime mortgages throws cold water on the housing market but won't throw the economy into a recession.

Loose standards for writing mortgages put less-than-creditworthy borrowers into houses they could barely afford over the past several years. Now it's payback time. Brokers complain that sales are falling through because buyers can't get mortgage commitments. As the tally of late mortgage payments rises, stories of families losing their homes are on local newscasts. Worries that the fallout would spread gave the stock market a jolt. So it's fair to ask: Will the mortgage mess tip the U.S. economy into recession?

No, it will not. But those bad lending habits will cause serious economic pain. Subprime loans to the least-qualified buyers and "Alt-A lending" -- that is, requiring little or no documentation of income -- made up about one-fifth of all first-mortgage debt last year. As lending standards have been tightened (and there's general agreement that they needed to be), buying has slowed at the bottom of the housing market. This could force move-up buyers who are depending on those sales to reprice their homes even lower. And that could lead to more declines in construction activity and reduced consumer spending. Not a very cheerful prospect, is it?

But it's all a question of degree. David Lereah, chief economist for the National Association of Realtors, believes tighter underwriting standards will only marginally reduce sales of existing homes this year and next, and he expects the inventory problems created by foreclosures to be short-lived. Even so, he sees the prices of new homes softening. Kiplinger's expects the average house price to decrease by 4% to 5% this year. Worst-hit by the subprime mess will be formerly hot markets with legions of subprime borrowers and speculators -- Chicago, California, southeast Florida, parts of the Pacific Northwest, and the Boston-New York corridor. Edward Leamer, director of the UCLA Anderson Forecast, says of these areas: "If you're a broker or a builder, it will feel like a depression."

But keep your perspective. At most, the housing market accounts for 8% to 10% of all economic activity, and other parts of the nation's economic engine appear to be humming along nicely. At 4.4%, the unemployment rate matches a five-year low. Leamer joins many other economists in predicting sluggish growth of 2% to 3% in coming quarters -- but no recession. Corporate balance sheets are pristine after a period of extraordinary profit and growth, making it hard to envision businesses cutting way back on hiring or consumer spending collapsing. Mark Zandi, chief economist at Moody's Economy.com, puts the odds of recession this year at just 1 in 4.