A gloomy day for the economy, except at the White House (7/15/08)

McClatchy NewspapersJuly 15, 2008 

WASHINGTON — President Bush began Tuesday trying to calm consumers troubled by an increasingly shaky economy, but his words had little effect.

By the end of the day, the Dow had closed at its lowest level in two years, the government reported that prices had jumped at their sharpest pace in 27 years, and the chairman of the Federal Reserve Board warned that "significant challenges" lie ahead.

Even the administration's plan to support the mortgage finance giants Fannie Mae and Freddie Mac — hurriedly announced over the weekend — didn't stem the tide. Both enterprises saw their stocks drop more than 25 percent.

The turmoil — the Dow Jones Industrial Average ended the day at 10,962, the first time it had closed below 11,000 in two years — clouded Bush's effort to use his first news conference since April to provide reassurance.

"The bottom line is this: We're going through a tough time," the president said in the morning."But our economy's continued growing, consumers are spending, businesses are investing, exports continue increasing and American productivity remains strong."

Shortly afterward, Fed Chairman Ben Bernanke looked at the same data and trends and saw a gloomier picture, describing in testimony before the Senate Banking, Housing and Urban Affairs Committee how Fed officials found that "considerable uncertainty surrounded their outlook for economic growth."

He said they "viewed the risks to their forecasts as skewed to the downside."

With no decline in gross domestic product, economists aren't ready to declare a recession, but Mark Vitner, senior economist at Wachovia, won't rule it out.

"If oil prices don't go below $130 by the end of the summer, it'll be hard for the economy to avoid a recession in the fourth quarter," he said.

Bernanke seemed most concerned about inflation, suggesting that rising energy prices soon would be felt throughout the economy.

But Brian Bethune, chief U.S. financial economist at Global Insight, said the economic upheaval should trump all other financial concerns for policymakers, even inflation.

"There's no question that this is the cusp of a major financial crisis and the Fed needs to get ahead of the curve," Bethune said.

The stock market's performance has added to investors' concerns about rising gasoline and food prices, mounting home foreclosures and upcoming earnings reports from financial institutions. Vitner said nervous investors might be suffering from information overload.

"There's just so much going on in so many parts of the economy that investors have been torn between whether things are finding a bottom or whether we've got more pain ahead of us," Vitner said.

Wall Street's mercurial day ended with the Dow falling nearly 93 points. Shares of troubled mortgage giants Fannie Mae and Freddie Mac continued their slides. Fannie Mae dropped $2.40 to finish at $7.31, while Freddie Mac slipped $1.69 to close at $5.42.

The declines of both mortgage financers occurred despite a new Securities and Exchange Commission plan to limit a certain type of stock speculation called "naked short sales."

Typically, short selling allows an investor to sell stocks he doesn't own but has borrowed. In naked short selling, the investor sells securities he's never borrowed. In both cases the investor expects the trading value to fall.

Experts say naked short selling promotes speculation and price volatility.

Bethune said the SEC's plan to curb naked short sales was another example of the government's "fire brigade mentality" in dealing with the financial crisis. Rather than taking proactive measures, the administration has stepped in only after problems occurred.

"This has been their modus operandi since the financial crisis has erupted, and it's not really working," Bethune said. "They've been running this game since last August in a reactive mode, and a year later the financial crisis is still with us. So maybe there needs to be some fundamental rethinking of how they approach this problem."

Vitner said he expected the Fed's next move to be an interest-rate cut, not a hike as some suggest.

In other downbeat news:

_ Wholesale prices were up 1.8 percent last month, the Labor Department reported. Producer price inflation has grown 9.2 percent in the last year, the fastest since 1981.

_ General Motors Corp., battered by the decline in auto sales, suspended its dividend and announced plans to lay off salaried employees and borrow up to $3 billion.

_ Oil prices fell by $6.64 to about $138 a barrel, as investors became concerned that the slow economy will dampen demand. But the price was still well above year-ago levels.

_ Retail sales were up a scant 0.1 percent in June, the Commerce Department reported Tuesday. Gas prices accounted for all the increase, Vitner said. "You take out gasoline prices and sales were down," he added.

Nevertheless, Bush boasted that tax-rebate checks were prodding spending.

Vitner countered that a good portion of the expected economic bounce from the checks has been siphoned away by higher gasoline and grocery prices. But he added that the extra cash was likely to keep the GDP in positive territory for the second quarter. "I'm not so sure about the third quarter, though," he said.

Bernanke said that businesses, stung by rising energy costs, are likely to pass those costs on to consumers "more aggressively than they have so far."

Such a scenario could be devastating. Bernanke warned that if the nation expects inflation to quicken, an inflationary spiral could "become embedded in the domestic wage-and-price-setting process (and) we could see an unwelcome rise in actual inflation."

Bush, who spoke at the same time Bernanke was testifying, remained cautiously upbeat, sometimes with a gritty stay-the-course line, sometimes by telling folksy tales to illustrate his points.

His most calming words concerned the biggest two crises the economy faces, rising energy prices and the increasingly shaky banking system.

"I think the system is basically sound, I truly do," the president said. "I understand there's a lot of nervousness."

Bethune acknowledged Bush's efforts to "rally the troops" and said the economy certainly would overcome the financial crisis.

Not before inflicting more pain on more Americans, however.

"When all the dust settles, we think a recession will be declared," Bethune said. "Because when the fiscal stimulus ends, we'll get a very weak fourth quarter and (first quarter of) 2009. The worst is yet to come."

McClatchy Newspapers 2008

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