Economists Weigh Recession Scenarios

It's hard for officials to even utter the word "recession." They have to keep a stiff upper lip and try to keep confidence high — but it's possible that battle is already lost. A new Associated Press-Ipsos poll reported Monday that 61 percent of Americans believe the country is already in recession. More and more economists are also moving into that camp.

"We do see the economy shrinking this quarter, and for the second quarter it's going to be very weak as well," says Bernard Baumohl of The Economic Outlook Group. "It's just going to feel quite awful. And it's going to result in the unemployment rate increasing and consumers cutting back on more spending."

Although he believes the economy is shrinking right now, Baumohl isn't quite willing to predict a recession, roughly described as two consecutive quarters of economic contraction.

"Well, if you're pinning me down, I will say that we will — by the width of a hair — formally escape a recession," Baumohl says. "But I don't think anyone's going to feel the difference between a recession and the kind of weak growth we're going to experience the rest of this year."

Many economists are firmly moving into the recession camp. Among them are forecasters at big Wall Street firms, including Merrill Lynch and Goldman Sachs — and at market intelligence firms like Global Insight, where economist Brian Bethune and his colleagues have just released a new forecast.

"For the first half of 2008, we're expecting a mild recession," Bethune says.

Employment will fall in housing-related industries, financial services and building material, Bethune says. Strength in export industries like aircraft, technology and software, and farm equipment will help keep the recession shallow, and the stimulus package will help keep it short, he says.

Global Insight also believes there's a 25 percent chance of a longer, deeper recession brought on by the failure of a large financial institution toppled by bad mortgage-based investments.

"That would be a very large domino. And we know what happens in the game of dominoes when a large domino goes down. It takes down a lot of smaller dominoes. That's the biggest risk," Bethune says.

What To Do About Credit

This meltdown in the financial system would likely cause credit to get even tighter, strangling potential growth, says Mark Zandi of Moody's Economy.com. He thinks a short recession is most likely, but he also thinks a longer recession is a real possibility.

Zandi says a recession could last well into 2009, or it could be what he calls a "classic recession" of declining activity through the summer and fall. "And then we have stop-and-go growth after that for the next couple of years where the economy just can't find its groove, similar to what Japan has suffered over the past decade — not to the same degree, but to a degree," Zandi says.

To avoid this scenario, Zandi believes policymakers need to think about creating a government entity to buy bad mortgages to clear up the picture in the financial markets so credit can flow again.

Zandi said that would be similar to the Resolution Trust Corp. that the federal government established in the early 1990s to resolve the savings and loan crisis and the credit crunch of that era. The RTC took over failed banks and auctioned off their assets. That effort cleaned up the banking system and saved taxpayers a significant amount of money.