Economy: Credit risks, housing market create uncertainty

While Bernanke's housing outlook is hardly upbeat, some analysts think he's far too optimistic. In particular, they dispute the Fed's analysis that problems in the housing sector haven't spilled into other areas of the economy — especially after the recent market churning from subprime — and that the falloff in housing will have only a small impact on consumer spending.

"The wealth effect (from rising home prices) equity extraction and excessive home building were absolutely necessary for this expansion to continue as long as it has or even continue at all," says Kevin Feltes, director of the Jerome Levy Forecasting Center.

Feltes predicts a broad retrenchment in consumer spending in the longer term, with borrowing and spending falling more than at any time since the early 1980s.

Economist Richard DeKaser of National City Bank, by contrast, says that even a sharp cutback in home equity withdrawals will have only a minimal impact on growth.

Benjamin Holzer, 36, of Queen Creek, Ariz., near Phoenix, says he's in pretty good shape, despite housing market troubles.

"I live in the most expensive house that I can afford," Holzer says, adding that the value of his home has risen so much since he bought it that anything short of a dramatic drop in real estate prices won't sting. "At the very worst, the market will come back down to a more normal situation. I'm in a good spot."

Consumer spending, two-thirds of the economy, held the recovery together in the early part of the year, but gains slumped this spring. Consumer confidence rose in July, but USA TODAY polls find a majority of respondents expect conditions to get worse.

"Things are getting more and more expensive; fuel is way up there. I've honestly had to stop working because my income wasn't helping. I was having to pay day care and extra gas; I was paying almost an extra $150 on gas a month," says Christina Howard, 32, of Port St. Lucie, Fla.

Economists have been counting on steady wage growth and a tight labor market to blunt some of the impacts of higher gasoline prices and the housing market slump. Job growth was below predictions in July, though the unemployment rate remains low at 4.6%.

"What we're seeing is that feeling you get when you're going to the dentist. … There's a lot of anxiety under the surface," says Phil Rist of BIGresearch, a consumer research firm.

Nervous about oil prices

Core inflation — minus food and energy prices — is declining at the same time as the inflation measure that includes all prices is under pressure. Oil prices hit a record high (not adjusted for inflation) of $78 a barrel last week, though they declined sharply Monday to a still-high $72.06 a barrel for light, sweet crude oil trading for delivery in September. The Fed focuses on core prices because they give a better sense of underlying inflation pressures. But that doesn't mean the central bank doesn't pay attention to the overall inflation number.

"We drive; we eat; we understand that inflation involves all prices, not just those that are not volatile," Bernanke told Congress.

A big risk is that higher energy prices will start to work their way through to consumers, pushing inflation as they slow the economy.

Cliff Waldman, economist at Manufacturers Alliance/MAPI, a trade group in Arlington, Va., says so far, manufacturers are able to weather the high energy costs, but their tolerance is "not limitless."

A strong worldwide economy is leading to stronger export growth, and improved technology has allowed factories to use less energy in their production processes, both factors that are aiding factories. But if prices were to go higher and stay there, it could cause problems for the economy, he says.

"As oil climbs, we have a reason to get a little nervous," he says.

Contributing: Barbara Hagenbaugh

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