Bush Names Advisor Ben Bernanke As Greenspan's Successor
Mark Wilson  /  Getty Images
Alan Greenspan, left, steps down Jan. 31 after more than 18 years in office, making way for Bernanke, center, a former Fed governor and current White House economic adviser. Bernanke was nominated by President Bush and is expected to win easy Senate confirmation next month.
By Martin Wolk Executive business editor
msnbc.com
updated 12/27/2005 2:04:09 PM ET 2005-12-27T19:04:09

Ben Bernanke will take center stage in 2006 when he assumes the mantle of Federal Reserve chairman, but he will share the spotlight with the housing market, whose performance is key to the economy’s future.

Bernanke takes the central bank rudder from Alan Greenspan as the world’s largest economy rolls into the fifth year of an expansion, with a slowdown in the red-hot housing market posing one of the biggest risks, especially in the second half of the year.

Forecasters polled as part of MSNBC.com’s fourth annual economic roundtable generally expect the housing market will avoid a catastrophic crash, although even if prices simply plateau it could remove one of the critical elements supporting growth over the past several years.

“I would say that as housing goes, so goes the economy,” said David Rosenberg, chief U.S. economist at Merrill Lynch. “I think one of the principal risks is whether or not home prices decline and the impact that that will have in terms of influencing the savings rate and personal consumption growth — as we have already seen in the U.K. and Australia.”

Ed Leamer, director of the UCLA business forecast, said the housing industry will no longer drive economic growth, but he does not expect prices to collapse. Instead he sees a long period of flat prices and a tougher market for sellers, especially in hot markets like his home state of California.

"It's going to be a buyer's market not a seller's market — possibly  for a long period of time," he said. But he said the downturn would not be enough to throw the economy into recession unless inflation fears send long-term mortgage rates soaring, which he does not expect.

The second half of 2005 was surprisingly strong considering Florida and the Gulf Coast region were hammered by three major hurricanes in three months including Katrina, by some measures the worst natural disaster ever to hit the country.

But the generally strong economic reports of the past several months mask lingering weakness in consumer spending that is partly the outcome of high prices for gasoline and home heating oil, said Diane Swonk, chief economist at Mesirow Financial.

“The economy looks better on paper than it feels to the overwhelming majority of Americans,” she said. “Middle- and lower-income Americans are stretching. They are continuing to get jobs — that is the good news. But they are not getting wage gains.”

She said the economy is likely to show some signs of a “midlife crisis” after more than four years of expansion, but predicted growth will accelerate again in 2007 as businesses continue to add jobs at a healthy pace, boosting consumer spending, which accounts for more than two-thirds of economic activity.

Most forecasters say the economy is entering 2006 with solid momentum that should carry through at least until midyear, when growth will slow slightly or substantially, depending on whom you believe.

Major Market Indices

“That is basically our outlook, that by the summer you’re seeing slower growth,” said Ethan Harris, chief U.S. economist at Lehman Bros. “Not a recession, but more of a slow patch.”

Joel Naroff of Naroff Economic Advisers is slightly more pessimistic, but agreed that a recession is unlikely in 2006.

“I’m not talking about recession, but I’m talking about a situation where we are talking about growth of 3 percent at best for the full year,” said Joel Naroff of Naroff Economic Advisors. “That, I think, is a distinct possibility. I think the interesting question is, will Mr. Bernanke be facing an economy that has begun to slow, but at the same time inflation is pushing up above where he would like to see it?”

Certainly Bernanke’s elevation to Fed chief will be one of the year’s critical milestones. Greenspan steps down Jan. 31 after more than 18 years in office, making way for Bernanke, a former Fed governor and current White House economic adviser. Bernanke was nominated by President Bush and is expected to win easy Senate confirmation next month.

The prevailing view is that Greenspan will end his tenure with one final interest rate hike at the scheduled Jan. 31 meeting of policy-makers and then Bernanke will follow suit with a rate hike at the first meeting he leads March 28.  After that the Fed is likely to move to take no action on interest rates for at least a few months, depending on how the economy performs.

“Greenspan will leave with one more hike … and then it is Bernanke’s turn,” said David Lereah, chief economist for the National Association of Realtors. “He will do one more hike because he’s got to show the markets that he means business.”

Two more rate hikes seem likely after a statement issued by the Fed this month said “some further measured policy firming is likely to be needed” to keep inflation pressures under control.

But some analysts suggest another scenario, saying that Greenspan could elect to leave rates unchanged Jan. 31 or raise the overnight federal funds rate a final quarter-point to 4.5 percent but declare that monetary policy is neutral, leaving a clear slate for his successor.

“It would be very, very easy for Greenspan to signal neutrality with the handoff,” said Michael Englund, chief economist for Action Economics. “It is still plausible the fed will stop at 4.5 percent, and in fact Bernanke will enter with a pause and have as his first order of business whether he will have to tighten again later in the year.”

Englund believes growth will be strong enough in 2005 that the Fed will have to resume hiking rates, eventually boosting the benchmark rate to 6 percent or more.

Rosenberg believes that would be disastrous, saying such rate hikes in the past have often pushed the economy into recession.

“I think the Fed is in the process of overshooting,” he said. “It’s always those last couple of rate hikes that tip the economy over. We could have either a soft landing or a hard landing. Or a soft landing in ’06 and a hard landing in ’07.”

The principle question for Fed policy-makers will be whether inflation pressures are building after more than four years of expansion, including a sudden surge to record high energy prices last year in the wake of Hurricane Katrina.

“If inflation does begin to move up a little faster than the Fed is comfortable with, they may have to keep raising rates even more into the summer or fall,” said Nariman Behravesh, chief economist for Global Insight. “That still doesn't look like a nasty scenario, but it would be a little slower.”

A more substantial inflation scare could send mortgage rates spiking higher and trigger the steep housing downturn that many fear. But Behravesh said even last year’s $3-a-gallon gasoline failed to spark much inflation in the broader economy.

“What we have learned over the last year and a half is that energy alone doesn’t do it,” he said.

Many Wall Street strategists are optimistic that the Fed will move to the sidelines quickly and help drive Wall Street higher after an uninspiring stock market performance in 2005.

Gary Thayer, chief economist of A.G. Edwards, cautiously backs that view.

“I think housing has been a preferred place to be while the Fed was raising rates,” he said. “When the Fed is finished equities will get more attention. I think next year could be as good as or better than this year. (But) we’re not at the beginning of the cycle, so there is not any undervaluation in price. We need to see a real change in sentiment to get a really good year in the stock market.”

And Thayer, who is optimistic about the economy next year, notes that investors have had plenty to worry about over the past year including a difficult war in Iraq, concern about terrorism, a wave of destructive hurricanes and soaring energy prices.

“If there is one thing we learned from 2005 it is that anything can happen at any time,” he said.

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