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Debt reduction may slow recovery
« on: May 19, 2009, 09:17:54 AM »

By Vivien Lou Chen

May 18 (Bloomberg) -- The need to boost savings and reduce debt may lead to “a substantial” slowdown in consumer spending or a jump in bank losses that will retard a U.S. economic recovery, according to economists at the Federal Reserve Bank of San Francisco.

“Either way, the process of household deleveraging will not be painless,” Reuven Glick and Kevin Lansing, economists at the district bank, wrote in a paper released today.

Taking the Japanese experience of the 1990’s as their guide, the economists estimated Americans may boost their rate of savings from current levels around 4 percent to 10 percent by 2018. Such a jump would trim three-quarters of a percentage point per year from consumer spending, the biggest part of the economy.

“The subtraction from consumption growth would act as a near-term drag on overall economic activity, slowing the pace of recovery from recession,” Glick and Lansing wrote.

“Taken by itself, this could be pretty grim,” said Michael Feroli, an economist at JPMorgan Chase & Co. in New York, who read the report. “A lot of people have this worry in the back of their minds.”

The Fed’s estimates for the savings rate are at the “upper range” of what most economists project will happen, which Feroli said was an increase in the range of 6 percent to 8 percent.

In any case, the main question for the U.S. is whether the anticipated slowdown in spending, whatever the magnitude, is accompanied by gains in business investment or exports that will help limit the damage to the world’s largest economy, Feroli said.

‘Valid Concern’

“If that happens, it could be a healthy rebalancing,” he said. “The concern is that all we really see is lower consumer spending. That is a valid concern that they raise.”

Glick and Lansing also said another way for households to reduce debt would be by defaulting on current loans through real estate short sales, foreclosures, or bankruptcy. This outcome would involve “significant costs” to consumers, including legal fees, lower credit scores and tax liabilities on foreign debt, they said.

“This form of deleveraging would simply shift the problem onto banks that hold these loans as assets on their balance sheets,” they said.

The San Francisco Fed is one of a dozen regional banks in the Fed system. The bank is led by President Janet Yellen.


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