WisBusiness: Economist Nichols predicts recession for 2008

By Brian E. Clark

MADISON – A top University of Wisconsin economist predicted today that the U.S. economy would slide into recession next year, led by the downturn in the housing market.

How severe that recession becomes remains to be seen, however, said Don Nichols, an emeritus professor of economics and former director of the LaFollete School of Public Affairs. He spoke as part of the university’s semiannual economic forecast conference at the Fluno Center on the UW-Madison campus.

“My money is on a near-term collapse in housing, a related decline in consumer spending a typical accompanying response (downturn) from inventories,” he said, noting that some sectors of the economy remain strong.

And, he said, he is going out on somewhat of a limb with his prediction because “most measures of economic activity do not yet support a forecast of recession.”

As for Wisconsin, Nichols said the impact of the housing slide and related credit crunch will be felt much less than in other areas of the country.

In part, that is because residential construction peaked in this state several years ago and new building permits for this July were about half of what they were for the same month four years ago.

He said he is bothered, however, by an employment rate growth that trails the national average. On the other hand, he said Badger State exports are booming by helping fuel China’s rapid economic expansion.

For the nation as a whole, he predicted the pending recession would occur because two bubbles have popped, or at least are deflating.

“One was the overbuilding and overpricing of house; the other was underpricing of risk,” he said.

Nichols said the collapse of subprime mortgages, made to borrowers with marginal credit, is triggering a “seizing up of credit and the repricing of risk.”

That has already been so sharp that he said it would have a significant and imminent effect on the economy.

“As we meet today, the market for home mortgages has greatly tightened; the market for commercial paper has seized up, credit standards for all kinds of loans including auto loans have suddenly been tightened; some hedge funds have gone under and more are likely to follow; and high-level investment strategies that once seemed fool-proof have been shown to have flaws,” he said.

Nichols said housing problems has begun to “leak” over into other sectors of the economy.

“Auto sales were surprisingly bad in July, with dealers claiming that housing was the cause of the slump,” he said.

“My call is that the consumer sector is weak right now… and will get worse before it gets better.”

He also noted a recent survey of chief financial officers by Duke University that said a third interviewed planned to postpone investment because credit has tightened. Others said their companies would curtail hiring.

The economist predicted moves by the Fed to relax interest rates by one-quarter percent would help. But he said he doubted if it would slice the rate by one-half percent, as some have forecast.