Can government turn the economy around?

While the ailing economy might need help right now, it is not clear how quickly a fiercely divided Congress can act. Any bill would have to work through both the House and Senate and then go through a conference committee before approval by the White House, which means nothing is likely to take effect until spring.

And when the dust settles, it’s not clear these measures will do much to prop up a faltering economy.

“For some individuals this could be important,” said Greg Valliere, chief political strategist at Stanford Group. “This could help the out them out of a very tight spot. But when you look at the economy as a whole, it’s awfully hard to see in the statistics how this type of stimulus has ever really made much difference."

The politics behind these proposals may be clearer than their potential impact. Democrats are eager to highlight the economy’s current problems and blame the Bush administration for the downturn. But Democrats who have vowed to contain federal budget deficits are wondering how increased spending or tax cuts would be paid for. Republicans seems to be taking a more wait-and-see attitude on spending. Some are warning about the negative impact of letting the tax cuts expire in 2010.

Politics aside, the economics of the current proposals are problematic in part because they don’t directly address the source of the slowdown: a housing market that shows no signs of hitting bottom.

The White House last month announced a plan to help head off a coming wave of mortgage foreclosures this year and next but conceded that only about a third of homeowners at risk would be helped. Fed Chairman Ben Bernanke said last week that lenders need to do a better job of speeding up the process of working with borrowers to head off loan defaults.

“You can lower taxes all you want and cut interest rates to zero," said Howard Glaser, a mortgage industry consultant and former HUD official during the Clinton administration. “But it’s not going to fundamentally affect the housing problems we have and bring investor confidence back unless we stop the death spiral of the housing market."

Lenders this week reported another round of losses from bad mortgages in the final quarter of 2007. Banking giant Citigroup said bad debts led to a $10 billion loss for the quarter, the largest in its 196-year history.

As more borrowers default, their foreclosed homes are being added to a glut of unsold properties, further depressing prices. Higher defaults also continue to weigh on the market for new home loans, especially large ones.

“The housing market generally is depressing the economy,” said Gramley. “We have a significant part of the credit markets that are simply dysfunctional. That’s potentially a very large problem.”

So far, consumers have held up relatively well. But there are signs that the housing recession may have begun to weigh on consumer spending, which accounts for roughly 70 percent of  economic activity. Job growth slowed to a trickle in December and more recent data show retail sales have weakened.

With house prices falling, the home equity that helped fuel spending during the housing boom has evaporated. Merrill Lynch economist David Rosenberg estimates that lost wealth could result in "a $360 billion hit to consumer spending over the next two years, which would be the equivalent of a 2 percent wage cut."

Supporters of a targeted stimulus package argue that putting money back in consumers’ wallets will help blunt the impact of that loss in wealth.

“What the anti-recession measures do is restore purchasing power that can reduce the secondary spillover effects — no matter where the recession starts,” said Stone.

If such measures are temporary, and come quickly enough, they could have some positive impact. But there’s also a risk that a “stimulus” package includes longer-term tax cuts or spending programs that don’t bear directly on boosting the economy — and only worsen the government's ongoing budget deficits.

“The question is: Is it the right medicine?” said Stuart Hoffman, chief economist at PNC Financial. “And what are the side effects if it makes the markets get more nervous about the hole you open up in deficit?”

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