Boston Fed chief sees end to turmoil

Says economy may be nearly normal in '09

The US economy could return to near normal by next year because of aggressive actions by the federal government, including this week's move by the Treasury to pump capital into banks by buying ownership stakes, said Eric Rosengren, president of the Federal Reserve Bank of Boston.

These actions, aimed at getting credit flowing again, should moderate the length and depth of the economic downturn, said Rosengren, speaking last night at the annual meeting of the Citizens' Housing and Planning Association, a nonprofit group.

"Economic and financial conditions have deteriorated recently, and while the housing and financial markets are most impacted, there is little doubt that the effects are spilling over to the rest of the economy," Rosengren said. "However, now with appropriate and determined policy actions underway, I believe much of the spillover can be mitigated and the economy can return to growth that is closer to potential next year."

Many economists expect the US economy to suffer one of its worst recessions in decades because of a financial crisis that began in US housing and mortgage markets, spread around the world, and accelerated into a downturn. The crisis has dried up credit, which businesses need to expand and hire, and consumers need to buy homes, cars, and other products.

The Treasury's bank investments, undertaken as part of the $700 billion financial industry bailout recently approved by Congress, aim to provide banks with capital they need to start lending. Earlier this month, the Federal Reserve said it will buy commercial paper, which companies issue for short-term financing to cover everyday expenses, such as payrolls. That credit market was virtually frozen.

The Fed also cut interest rates by a half-percentage point as part of a coordinated action with foreign central banks. Other governments, notably the United Kingdom's, are also injecting capital into banks in return for ownership stakes.

Over the next several months, Rosengren said, policy makers must continue to make sure credit keeps flowing and lenders have sufficient capital to make loans. In addition, policy makers must take steps to stabilize housing markets, including helping to prevent foreclosures.

With the economic downturn, foreclosures are affecting a far broader population than just those who took risky, high-interest loans known as subprime loans. About half of all foreclosures in Massachusetts in 2006 and 2007 involved prime borrowers, according to research from the Boston Fed.

One way to help prevent foreclosures is to bring together borrowers and lenders to renegotiate loan terms, Rosengren said. In August, the Boston Fed sponsored a foreclosure prevention workshop that brought together 20 loan-servicing companies and more than 2,000 borrowers. About one-fourth of those borrowers had their loans modified, while 39 percent were waiting to hear from lenders about possible adjustments, according to preliminary results from a survey.

Of those who received modifications, more than 60 percent had interest rates reduced; 42 percent received temporary reductions in monthly payments; and 6 percent received a reduction in principal.

"Ideally, borrowers and lenders won't wait for these large events before initiating fruitful discussions," Rosengren said. "Ideally, with new legislative initiatives and actions recently announced by the US Treasury, more forceful actions will be taken by all participants - actions that in sum will help stabilize the housing market and benefit all its participants."

Robert Gavin can be reached at rgavin@globe.com.