Fed's Lockhart: Credit crisis threatens economy

By Pedro Nicolaci da Costa

NEW ORLEANS (Reuters) - Stressed financial markets risk doing severe damage to the broader economy, Atlanta Federal Reserve President Dennis Lockhart said on Tuesday.

The United States is experiencing its worst credit crisis since the Great Depression, a downturn that began with troubles in the housing sector, particularly rising foreclosures and falling home values.

The economy as a whole has managed to eke out some modest growth thus far, but many economists believe a recession may already be under way.

"Problems in our financial system add significant risk to the downside for the economy," Lockhart told a business group in prepared remarks.

On Monday, the U.S. House of Representatives rejected a $700 billion bailout plan, driving the Dow Jones industrial average down 778 points -- its worst-ever drop in terms of points.

The market rebounded on Tuesday, with the Dow up 400 points, or almost 4 percent in afternoon trading, on hopes for a second attempt, but Lockhart said he did not see a comprehensive package making it through Congress.

Lockhart said things had become worse rather than better over the last month, noting a considerable deterioration of market conditions and ever rising reluctance on the part of banks to lend.

"There has been a widespread withdrawal of confidence in counterparties that has resulted in efforts to reduce exposure," Lockhart said.

Against that backdrop, demand for liquidity from the Fed, already high, has picked up significantly, the Atlanta Fed president said.

LAYOFFS SPREAD, HIRING PLANS EBB

He added labor market conditions had also become more dire, with layoffs becoming more widespread and hiring intentions fading fast.

In this context, Lockhart said inflation would likely be less of a problem.

"I feel better about inflation," he said.

Still, he did not offer any hints that the Fed will cut interest rates again, as futures markets now appear to be expecting.

"I expect the Fed will push the funds rate down by 50 basis points by early in 2009," said Dana Johnson, chief economist at Comerica Bank.