Page last updated at 10:53 GMT, Tuesday, 9 December 2008

US faces deep problems, OECD says

By Steve Schifferes
Economics reporter, BBC News

Dollars
The world's biggest economies have been hit by the credit crunch

The US economy is still facing "sharp downside risks" to growth, according to the Organisation for Economic Co-operation and Development (OECD).

The Paris-based organisation warns that the credit squeeze has been spreading to other forms of lending, and other financial firms could become insolvent.

It says that another fiscal stimulus could be needed if things get worse.

But it warns that longer term problems, including health care reform and the US budget deficit, must be tackled.

Obama's challenge

The OECD paints a grim picture of the challenges facing the incoming Obama administration, which takes office on 20 January.

It says that "the US economy is going through an exceptionally difficult period" and despite major policy interventions, it is likely that "activity will get worse before it gets better".

The OECD suggests that the weakness will continue well into 2010.

It also warns that "house prices appear to have further to fall, and foreclosures are widely expected to rise."

Car production line
The real economy is predicted to decline through 2010

The decline in household wealth of about 20%, due to falls in the stock and housing markets, is likely to affect spending and household consumption.

The OECD broadly endorses the need for a further stimulus plan, saying that "macroeconomic policy should stand ready to provide a renewed stimulus".

But it warns that, "given the underlying fiscal situation, the package should aim to be strictly temporary, timely and targeted" - an approach that appears to differ from the plan for big infrastructure projects that President-elect Obama has talked about.

And it adds that in the longer term, "the ageing of the population and other trends put the Federal budget on an unsustainable course" and says that increased tax revenue and controls on spending will be needed.

Financial disruption

The OECD says that "resolving the financial crisis could be a long drawn-out process", which could require substantial government spending just as in previous banking crises.

It says that the "full effects of the forceful easing of monetary policy will only be felt after financial market conditions normalise".

So it argues that big rate cuts by the US central bank, the Fed, "appear to be roughly appropriate in light of the adverse effect on real activity" of the credit squeeze, and says that "monetary policy should remain highly accommodative for quite some time to support the economy and the financial system".

However, it warns that in the long run, the regulatory system needs to be fundamentally reformed, or else the rescue of troubled financial institutions "could inadvertently serve to encourage imprudent behaviour" in the future.

"A major overhaul of regulatory and supervisory policy is necessary to remedy the deficiencies in oversight that the crisis revealed," the report says.

It also calls for reform of the supervision of mortgage brokers, underwriters and credit agencies to protect borrowers and investors.

And it says, more controversially, that in the long-term "it would be preferable to leave the securitisation of mortgages to the private sector," eliminating or reducing the role of the big government-sponsored agencies, Fannie Mae and Freddie Mac, which were effectively nationalised by the government earlier this year.

Health care reform

The OECD report has a special chapter highlighting the problems of the US health care system, which was much debated during the recent election campaign.

It points out that, despite spending 15% of GDP, "the health status of the US population does not appear to fare well by international comparison".

The OECD endorses the goal of the Obama administration in making progress towards providing health care insurance for all Americans.

However, it appears to give support to the plan proposed by his electoral rival, John McCain, to replace tax subsidies to employers with subsidies to individuals to choose their own health plans that would not be tied to their jobs.

It says the current system is regressive and encourages people to buy expensive plans, as well as reducing job mobility.

But it also suggests that reforms suggested by president-elect Obama, such as a requirement to have health insurance, and regulating insurance companies more tightly so they must accept all applicants, "are likely to be necessary to expand coverage substantially".

And it warns that the government will have to take tough measures to control costs in state-run Medicare system of health insurance for older people.

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