Wall Street firms see recession nearing

NEW YORK (Reuters) - The U.S. economy might be edging toward a recession in the wake of mortgage-related credit woes plaguing the financial markets, bankers and analysts said on Monday.

"I think that the risk of a recession is greater than people realize," James Dunne, chief executive of Sandler O'Neil & Partners, said at the Reuters Finance Summit in New York.

With home prices dropping, more people about to lose their homes due to unaffordable mortgages and sharply higher oil prices, the economy could be on the brink of slowing down, they said.

"I think there is a serious risk to the economy," Howard Lutnick, CEO of Cantor Fitzgerald, told the summit.

Charles Peabody, partner at New York-based research firm Portales Partners LLC, said the Fed may have to take more aggressive action and drop the benchmark fed funds rate in an effort to prevent a Japanese-style economic stagnation, which eventually evolved into a deflationary recession.

"We're moving into a recession, and over time -- the length of which is difficult to predict -- there is going to be a lot more credit problems," he said.

Preliminary data released by the U.S. government last week showed that the gross domestic product grew by 3.9 percent in the third quarter, compared with 3.8 percent in the previous quarter and 0.6 percent in the first three months of this year.

Last week the Fed announced at the end of a two-day meeting of its policy-setting Federal Open Market Committee that it was reducing its federal funds rate a quarter percentage point to 4.5 percent, citing its expectation that "economic expansion will likely slow in the near term" because of the housing sector's problems.

The Fed noted that growth was "solid" in the third quarter and said it thought financial-market strains were easing, but still opted for some insurance to add stimulus.

When asked where the U.S. economy is headed over the next year or so, John Duffy, chairman and CEO of Keefe, Bruyette & Woods, said at the summit: "In the toilet."

With the recent data and Fed moves, Wall Street firms believe the Fed will be forced to reduce interest rates on loans to banks to 3 percent, or even as low as 1 percent, at least over the next year.

Duffy said Fed action alone will not cure what ails the U.S. economy and financial institutions, which are experiencing a liquidity squeeze in the markets for credit and other financial products.

"I don't think they (the Fed) have a silver bullet,' he told Reuters.

(Additional reporting by Jennifer Ablan and Anupreeta Das)

(For summit blog: summitnotebook.reuters.com/)

(Reporting by John Poirier)