Fed's Evans says double-dip risk has risen

Chicago Federal Reserve Bank President Charles Evans in Hong Kong, March 30, 2010.

INDIANAPOLIS (Reuters) - The risks of a double-dip U.S. recession have risen in the last six months, Chicago Federal Reserve Bank President Charles Evans said on Tuesday.

While a new contraction in the economy is still not the most likely scenario, high unemployment and a fractured housing sector make this recovery a fragile one, he said.

"A double dip is not the most likely outcome but I am concerned about how strong the recovery will be," Evans said at a housing event in Indianapolis.

Against that backdrop, Evans said the Fed's ultra-easy monetary policy is appropriate.

In response to the financial crisis of 2007-2009, the U.S. central bank cut short term interest rates to near zero, and also undertook a host of emergency measures such as U.S. Treasury bond and mortgage debt purchases to keep borrowing costs down.

The Fed announced earlier this month it would add to this stimulus by investing proceeds from maturing mortgages securities in its portfolio into Treasury debt.

Evans said unemployment, currently at 9.5 percent, is likely to remain uncomfortably high for the foreseeable future.

His comments came just before a report on existing home sales showed a record monthly drop in existing home sales to their lowest level in 15 years.

PERVERSE INCENTIVES

In his speech, Evans argued that the securitization process, in which mortgages are repackaged into bonds that are then sold to investors, reduces the incentive of lenders to modify troubled home loans.

In remarks that focused on the country's housing market weakness and various attempts to ease it, Evans said efforts to modify home loans to prevent foreclosure were a "drop in the bucket" compared with the problem at hand.

"The securitization process appears to have created conflicts between the interests of servicers and lenders," Evans said. "These and other impediments have kept the number of modifications lower than we might have hoped."

The U.S. housing market has been in a downturn for about three years now, with home construction running at less than a quarter of its boom-time peaks and prices down sharply across the country.

Many economists worry that, without housing as an engine of growth, the economy could take much longer than usual to recover.

Evans also cast some doubt on the value of financial education in preventing mortgage and other borrower distress, a break from Fed tradition.

"Staff members at the Chicago Fed have recently undertaken a thorough review of studies evaluating the effects of financial education. What they find is that the evidence on the effectiveness of education and counseling is rather mixed," he said.