Odds grow for recession, but lenders hold the key

Wall Street's woes are raising the risk that the U.S. economy could sink into recession late this year or early next year.

Although few economic analysts put the odds of recession at better than 50 percent, most are now upping their probabilities.

"We've lowered our 2008 growth forecast to 1.5 percent, down from 2.3 percent previously and 1.8 percent in 2007. We now expect a consumer recession, for the first time in 17 years," said a revised forecast issued Thursday by Merrill Lynch.

Whether Wall Street's turmoil brings a sharp slowdown or a full-blown recession depends on three interrelated variables: how quickly banks resume lending to businesses and home buyers; whether the recession in the housing sector bottoms out or deepens; and whether falling home prices and a lack of lending combine to hit the consumer's ability to spend.

"What we're going through now is unlike anything we've seen before. All financial crises have their unique characteristic - this one is characterized by a seizing-up in the home-mortgage market," said Lyle Gramley, a former governor of the Federal Reserve System in the 1980s who's now with the Stanford Group, a consulting firm. He puts the odds of recession at 50 percent.

Gramley was referring to the spate of bankruptcies by companies that issued home loans to risky borrowers - and increasingly companies that gave loans to credit-worthy homeowners.

Gramley's concerned that there aren't good measures right now of how much lenders are pulling back. "None of us knows for sure how much credit availability has declined, but to be sure it is substantial," he said.

If banks don't extend credit, businesses can't borrow to grow. Nor can they issue bonds to finance expansion, since investors are fleeing virtually all forms of risk. If businesses don't grow, they don't hire. If this trend goes on very long, eventually it will lead to higher unemployment figures.

The Dow Jones industrials, down more than 340 points in afternoon trading on Thursday, ended the day losing just 15.69, or 0.12 percent, to 12,845.78.