US May Be Running Out Of Options To Stop Recession

Now what?

After a bailout of Fannie Mae and Freddie Mac , $168-billion of fiscal stimulus measures, a housing-rescue package and three-and-a-quarter percentage points worth of Federal Reserve interest rate cuts, the economy is still struggling and in some ways looks worse than ever.

And while the recent one-two punch of rising joblessness and shrinking payrolls restarted the recession debate, it begs an even bigger question: What will it take to bring the economy back to health, especially in a presidential election year?

“The answer is quit making dumb mistakes,” says Dan Mitchell a senior fellow at the Cato Institute.

Mitchell’s answer is actually a lot more complicated that it appears.

As an ardent supply-side economist, he’s inherently opposed to government intervention in the free markets. But he’ll also tell you that most of what the federal government has done is meant to ease the popping of the housing bubble, which it created in the first place, thanks to artificially low interest rates, government-supported mortgage lenders and liberal lending requirements.

This past weekend's government takeover of mortage giants Fannie and Freddie was just the latest example of that. Still, many on Wall Street are skeptical that the bailout will do much to resolve the housing and credit crisis.

“The best thing to do is to let housing prices reach their natural level as soon as possible, so people know what's real and what's not,” Mitchell says.

Like that’s going to happen. If not, then what will?

Chances are nothing, at least in the short term, given the November presidential election.

“We're not going to get anything done until after the inauguration,” says Robert Brusca, chief economist at Fact & Opinion Economics. “March at the earliest.” After any legislation becomes law, add another couple months for the money to start to hit.

Interventionism aside, the government’s fiscal measures thus far have drawn mixed reviews from economists. At best, they helped to slightly soften the blow of the credit crunch and slowing economy. At worst, the return on investment was low because the measures were ill conceived in the first place and in the end not enough of the tax rebate money was spent and thus put back into the economy.

“The fiscal stimulus seemed to be designed to maximize the likelihood of the re-election of the incumbent.” Nomura International Chief Economist David Resler.

“We would have been better off, if we had announced right then and there that we would extend the Bush tax cuts, which would have had a more direct impact,” says Resler.

“If you cut taxes, it affects peoples stream of income,” Brusca. They’re more likely to spend money than with a one-time refund.”

Others say there’s a remote chance that a lame duck Congress and president might work with incoming leaders to throw more money at the problem, should it be abundantly clear the economy in recession in November.

There’s more of a chance the Fed will lower interest rates again, economists say, but they would require greater confidence that the oil bubble is over and the dollar rebound is for real.

“The Fed is kind of sitting there in a bind,” says economist Dean Baker of the Center for Economic Policy Research, because inflation is too high and growth too weak.

He says another rate cut– either a quarter percent or a half percent—would be extraordinary, but these are extraordinary circumstances.”

Some Fed members might certainly agree, having seen the FOMC’s  aggressive monetary easing do little to lower mortgage rates and trigger the normal borrowing activity that stimulates economic growth.

“The economy is definitely weaker than the fed had expected,” says Brusca.

And though it is rare for the central bank to change interest rates before a presidential election, both of the political parties could spin a rate cut to their advantage.

“I'm not sure anything it could do would be particularly helpful,” adds Resler. “The problem is not that there isn’t enough liquidity. The problem is that the liquidity there isn't finding its way to end users.”

Much may depend on how evident the economic deterioration is. Many economists are now convinced the US is in recession. There’s considerable debate, however, as to whether the worst is over or yet to come and how long the contraction will drag on, even if the labor markets continues to show signs of distress.

“I'm not even beginning to think about emerging, we're still sliding down,” Nobel prize-winning economist Martin Feldstein told CNBC Friday.

Feldstein, who’s also president emeritus of the Bureau of Economic Research, the official arbiter of recessions, is among those who isn’t ruling out a flat or negative GDP number in the third and fourth quarters. If that’s the case, the recession would be a year old, assuming it started in December, as some economists do.

(Watch the accompanying video to hear more from Feldstein...)

Even more interventionist-oriented economist like Baker see little chance of immediate improvement, especially if more of the usual remedies are applied.

“We're not going to get this fixed until we get the dollar down and the trade deficit at a more manageable level,” says Baker, whose equation calls for less imports, more exports and more jobs.

For Mitchell, however, less is more.  “If the economy happens to hit a bump in the road the best thing to do is let market forces bring it back."

© 2009 CNBC.com