Forecast puts stocks in a funk

Times Staff Writer

The nation's top two economic policymakers predicted Thursday that the United States would probably dodge a recession, but just barely. The economy itself, meanwhile, threw off conflicting signals about whether it was improving or deteriorating.

Federal Reserve Chairman Ben S. Bernanke told a Senate committee that "the outlook for the economy has worsened in recent months and the downside risks to growth have increased." And he said central bank officials stood ready to cut interest rates further to counteract the effect of the slumping housing market, weak employment and financial institutions that remain deeply reluctant to lend.

Bernanke suggested the bank's efforts ultimately would prove successful.

Appearing at the hearing with Bernanke, Treasury Secretary Henry M. Paulson Jr. declared that the economy was "strong, diverse and resilient," although he said it was undergoing "a significant and necessary housing correction."

The economy will continue growing, he said, but "its pace in the coming quarters will be slower than what we have seen in recent years."

The somber tone from Bernanke and Paulson helped depress the mood on Wall Street, ending a three-day rally in stocks. The Dow Jones industrial average sank 175.26 points, or 1.4%, to 12,376.98.

Markets also were unnerved by more signs that the credit crunch in mortgages was spreading to other corners of the financial system. In recent days anxious investors have balked at buying certain corporate and municipal bonds, driving up interest rates on those securities.

As it has repeatedly since last summer, the economy continued to send up contradictory signals.

On Thursday, the government reported that the nation's trade balance, although still in the red, substantially improved in December and for all of 2007, despite record foreign oil prices.

The U.S. exported $144.3 billion of goods and services in the last month of the year, a $2.2-billion improvement over the month before. It imported $203.1 billion of goods and services in December, $2.2 billion less than in November. For 2007 as a whole, the U.S. ran a trade deficit of $711.6 billion, down nearly $50 billion from 2006, the government said.

The trade report came a day after a report on January retail sales showed unexpected growth.

Some analysts drew a dotted line between the trade and sales numbers to conclude that the economy might not be in quite as bad shape as most people had thought. "Nobody can say we're performing satisfactorily, but it's not inevitable we're going into recession," said Ken Mayland, head of forecasting firm Clearview Economics in Pepper Pike, Ohio.

Mayland estimated that the new trade figures would force government statisticians to revise upward the nation's anemic growth rate for the fourth quarter of 2007 from the 0.6% already reported to perhaps as much as 1%.

But other economists suggested the latest numbers would make little difference in the final figure for the gross domestic product, the broadest measure of U.S. output of goods and services.

"When everything is taken into account, we're likely to end up where we started -- at 0.6%," said Nigel Gault, chief economist with Global Insight Inc., a Boston-based forecasting firm.

Although the trade and retail sales data offered glimmers of hope, there was fresh evidence that the housing slump worsened toward the end of last year, and new signs that the volatile financial markets might be headed for another round of trouble.

The National Assn. of Realtors reported that home prices fell during the last three months of 2007 in 77 of the 150 metropolitan areas the industry group surveys. Among the biggest losers: the Los Angeles-Long Beach-Santa Ana area, where prices plunged 13.1% from a year earlier, and San Diego-Carlsbad-San Marcos, where they dropped 9.8%.

Nationally, the median price of existing single-family homes sold in the fourth quarter was $206,000, down 5.8% from the last quarter of 2006, the group said.

The home price report came after Swiss banking giant UBS said it would take a major write-off as a result of losses on U.S. mortgage-backed securities.

Wall Street players have known for months that when it came time to close the books on 2007, big banks and investment houses would have to declare steep losses on mortgage-related securities because of soaring defaults on home loans.

Still, the staggering dimensions of the losses have helped drag down stock markets worldwide this year.

UBS said it took a $13.7-billion write-down on U.S. mortgage bonds in the fourth quarter, including $2 billion on bonds backed by so-called alt-A loans -- a category considered to be higher quality than the sub-prime loans that have been at the center of the housing crisis.

The risk of rising losses even on mortgages previously considered relatively safe sent a new chill through financial markets. UBS' U.S.-traded shares sank 8.3%.

What's more, interest rates on some municipal bonds rose sharply for a second day as investors remained reluctant to buy the securities. The muni market has been riled amid doubts about the financial health of insurance companies that guarantee the bonds, as the companies reel from losses on sub-prime securities they also have guaranteed.

In his testimony before the Senate Banking Committee on Thursday, Bernanke appeared to be particularly concerned about spreading trouble in the markets.

He described a vicious cycle in which the sub-prime crisis had a domino effect that included "a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial institutions to credit losses, and concerns about the weaker outlook for the economy."

Bernanke warned that the sequence had made financial institutions "more restrictive in their lending to firms and households," threatening, in turn, to weaken the economy further.

The Fed chief traced the worsening outlook for the economy in part to this kind of cycle, and warned that further problems could lie ahead for housing and the labor market.

If those conditions develop, Bernanke pledged, the central bank "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks."

To date, the Fed has slashed its benchmark federal funds rate, which banks pay each other for overnight loans, by 2.25 percentage points to 3%. It has reduced the separate discount rate at which the Fed makes loans to banks to 3.5% from 5.75%, and has started a series of auctions to make short-term loans to banks.

peter.gosselin@latimes.com

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