U.S. at risk of recession from housing

JACKSON HOLE, Wyoming (Reuters) - The weak housing market could topple the country into a full-blown recession and the Federal Reserve should slash interest rates aggressively, one of the country's most prominent economists warned on Saturday.

"Lower interest rates now would help," Martin Feldstein, president of the influential National Bureau of Economic Research, told an annual retreat of central bankers and academics, including a number of senior Fed policy-makers.

Feldstein, who warned of a "multiplier effect" from declining home prices and lower consumer spending, said a cut of as much as 100 basis points might be warranted.

The symposium, hosted by the Federal Reserve Bank of Kansas City in the Grand Teton mountains, is examining the implications of a meltdown in the U.S. subprime mortgage market for borrowers with risky credit.

Evidence the problems have spread to Europe and Australia has hit the availability of credit and roiled financial markets worldwide.

Fed Chairman Ben Bernanke also attended the symposium but left before Feldstein made his remarks.

In a speech on Friday, Bernanke said the Fed would not rescue investors from self-inflicted losses. But he said it would not stand by and allow innocent people to suffer from a wider slowdown, and would it act -- cutting interest rates -- if it was persuaded by the economic evidence.

Financial futures indicate a 100 percent likelihood that the Fed will lower its overnight funds rate by a quarter percentage point to 5.0 percent when policy-makers next meet, on September 18.

Feldstein, who was one of the front-runners for the top job at the Fed until Bernanke was picked for the post, saw three challenges to U.S. growth from housing: declining home prices; the subprime mortgage crisis; and weakening home equity withdrawal and refinancing.

Those three problems "point to a potentially serious decline in aggregate demand," he said. "The multiplier effect of home price declines and declines in consumer spending could push the economy into recession."

Feldstein said he understood there was a moral hazard issue if the central bank was seen to be bailing out reckless speculators, whose rash bets got the country into the problems it now faces.

Moral hazard describes the trap faced by central bankers if they bail out investors for reckless decisions, thereby encouraging more risk-taking in the future.

But he urged policy-makers not to throw the baby out with the bathwater.

"It would be a mistake to permit a serious market downturn just to avoid helping those market participants," he said.

Feldstein acknowledged that policy-makers faced a dilemma: cut rates and face higher inflation later, or fail to move and fail to avert recession.

"A sharp reduction in the interest rate would attenuate that very bad outcome," he said.