Fed officials suggest worst of recession is over

NASHVILLE, Tenn (Reuters) – Top U.S. officials on Saturday offered reassurances that the worst of the economic downturn is likely over, helped by unprecedented efforts to keep credit flowing, though the recovery will be slow.

Two Federal Reserve policy-makers, Vice Chairman Donald Kohn and New York Fed chief William Dudley, both pointed to signs that measures taken by the U.S. central bank are indeed working to help revive the economy.

And Paul Volcker, a senior economic adviser to the Obama administration and a former Fed chairman himself, said the rate of the economy’s decline is set to slow.

Volcker, who like the other officials spoke at a conference of policy-makers and academics at Vanderbilt University, said, however, that the economy faces a “long slog” toward recovery.

Fed officials often stress that there is a lag before the economy responds to measures taken to support growth, such as interest rate cuts, and that those lag times can vary.

Since the financial crisis erupted in 2007 the Fed has slashed its benchmark lending rate from a peak of 5.25 percent, reaching the current range of zero to 0.25 percent in December 2008.

The Fed has also created an alphabet-soup of programs to support credit markets and revive lending in different segments, especially home mortgages.

While the central bank’s emergency measures have caused the Fed’s balance sheet to balloon to over $2 trillion, Kohn and Dudley dismissed worries that the measures could lead to inflation down the road, saying they have plenty tools to drain excess cash from the system when necessary.

THE GREAT RECESSION

Volcker, known for aggressive interest rate hikes to combat spiraling inflation when he was the Fed chairman in the 1980s, said the unprecedented tumble in economic activity in late 2008 may not have left the United States in a Great Depression but has left it “in a great recession for sure.”

“None of us has seen a decline in economic activity at the rate of speed seen late last year,” said Volcker, who has been enlisted by Obama as part of a heavyweight economic team.

Most economists see the fourth quarter of 2008, when gross domestic product shrank by 6.3 percent, and the just-ended first quarter of 2009 as the low point.

Kohn stressed that the current recession is “global, and will require a global response.” He said the era of relying on the free-spending U.S. consumer was over and that the phenomenon was “never sustainable.”

Now, “U.S. consumers are pulling back, obviously, and are going to be amassing savings by not spending,” he said.

But even with the United States now in its sixth quarter of recession, Kohn said the central bank’s attempts to heal ailing credit markets and spur an economic recovery have been working gradually.

“The situation in financial markets and the economy would have been far worse if the Federal Reserve hadn’t taken the actions we did,” he said.

In another sign that the economy may be on the mend, Frank Nothaft, the chief economist of Freddie Mac, the No. 2 U.S. provider of home finance, said housing sales are near a bottom. A recovery in the housing market is seen as crucial to a turnaround in the economy.

Nothaft, speaking on a panel at the conference, said a third of sales are now of foreclosed properties.

But while the worst may be almost over for residential home sales, Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, warned problems in the commercial real estate market pose a real risk to the economy.

Problems in the commercial property market were highlighted earlier this week when General Growth Properties Inc (NYSE:GGP – News), the second largest U.S. shopping mall owner, filed for bankruptcy protection.

Volcker, meanwhile, said troubles in the financial system continue to work against the economy, and vice versa: “The lack of a good strong recovery works against a strong financial system.” The financial system, he said, “is not quite comatose, but it’s on life support.”

Dudley, president of the most important regional Fed bank, said that while the emergency programs were in general working to stabilize markets, some are being undermined by a perceived stigma attached to their use.

Political outrage over lavish bonuses at banks has made some investors wary about taking part in the Fed’s ambitious new program to spur consumer and business lending. Some investors have worried that they could become the focus of political outrage if they were seen as profiting from the program, or that there would be hidden strings attached.

“It is worth emphasizing (that) actions that lead investors to shun taking risk, especially in this environment, are ultimately detrimental to the ability of households and businesses to secure credit at reasonable borrowing rates,” Dudley said.