WisBusiness.com: UW-Madison prof says U.S. economy approaching brink of recession

By Brian E. Clark

MADISON — The U.S. economy is approaching the brink of recession and the stumbling housing market could drag it over the edge, UW-Madison emeritus economics professor Don Nichols said Friday during an economic outlook forum at the Fluno Center.

But Nichols said he could not predict what will happen with housing during the rest of 2007.And because Wisconsin’s economy is based more on the export of manufactured goods, the Badger State could have a “relatively good” year and even beat the national growth average if “the housing bust becomes huge,” he said.

“The housing decline will be far worse in other states than Wisconsin, though it will certainly be felt here,” he said.

Nichols noted that former Federal Reerve Board Chairman Alan Greenspan has said the chances of the U.S. sliding into recession are one in three. Nichols assessment is more sobering: He said he believes the odds may be as great as one in two.

The former head of the La Follette School of Public Affairs at the UW-Madison said the housing sector has “long tentacles.”

“Economic growth has already fallen from the 3.5 percent range to near 2 percent because of the decline in residential construction alone,” he said. “More declines are yet to come.”

Nichols called hosing a “bloated sector” that has been overbuilt and oversold for several years. “A correction will require a decline in the construction of new hoses and in many places, house prices,” he said.

For 2007, he said a drop in residential construction from 6.5 percent to 3.5 percent of the gross domestic product (GDP) would cause a decline of about $400 billion in the nominal GDP. If that happens, he said the national growth rate would fall to zero and trigger a recession.

In the case of a decline to 4.5 percent of the GDP – a more likely scenario – he said a $260 billion gap would have to be filled and a growth rate near 1 percent could be expected.

Nichols had especially harsh words for subprime lending practices, which entice borrowers with poor credit ratings to sign up for so-called “teaser” payments for the first two years with a jump to market rates delayed to the third year. He urged tighter regulation of what he called “funny money” mortgages.

Though many people with what he called “absurd” mortgages will lose their homes, he said the country’s overall financial system will not “seize up” over the mortgage finance issue.

“As long as borrowing remains possible, as long as difficulties are not revealed in sectors other than housing finance, we are likely to emerge from the housing disaster without a major credit crunch,” he said.

In addition its negative impact on the GDP, he said the housing crisis may cause homeowners whose mortgages are not in trouble to cut back on their spending – which could also help push the economy into recession.

Fortunately, Nichols said, other areas of the U.S. economy look fairly solid.

“After the high stakes drama now being played out in the housing market, the minor uncertainties of the outlooks for the other sectors is quite tame,” he said.

Because Wisconsin’s economy is buoyed by exports, it should benefit from the forecast that overseas sales should continue to grow, he said. Moreover, a continuing decline in the value of the dollar will make U.S. products more attractive.

With a lesser decline in housing and a greater reliance on exports and equipment investment, the Badger State should have a relatively strong year, he predicted.

“Since the rest of the country usually grows faster than the northern manufacturing belt, a ‘relatively good year’ means we could grow at the national average, and if the housing bust becomes huge, we could beat the national average,” he said.

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