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The deterioration in economic conditions in the U.S. is more severe than he had anticipated, Kansas Federal Reserve President Thomas Hoenig told in an interview to PBS` Nightly Business Report on Monday. He acknowledged that the U.S. is in a recession despite the steps taken early on in providing liquidity and with the actions around monetary policy and even the fiscal tax rebate that was expected to stem the rot.

Hoenig attributed the faster-than-expected decline in economy activity to consumer spending that has slowed down due to consumers conserving so much out of uncertainty and fear. Additionally, the Fed President said business investment has slowed and exports, though are contributing to growth in the third quarter, is slowing down, while government spending is still holding up. 

Economic reports released last week reinforced the view that the economy faces the grave threat of falling off a cliff. Consumers are pulling back like never before, as the economy grapples with the slowdown. Wachovia Securities expects a more than 3% drop in consumer spending in the fourth quarter following a 3.1% decline in the third quarter.

Confirming the weakness in consumer spending, retail sales fell by 2.8% in October. With the decline, retail sales have been dropping for each of the past three months. On a more negative note, the August and September readings were revised down. Auto sales showed weakness, while core retail sales that feed into real consumption spending also declined by 2.3%.

When asked whether the current recession is the worst in the post-war period, Hoenig said, `It isn`t yet and it doesn`t have to be and that will depend on how the psychology of the marketplace works. We have a new administration coming in, what it does. I think the fact that we have a very accommodative policy is a factor offsetting the slowdown to some degree and we then we know under discussion are some important fiscal stimulus discussions.` He added, `What those are, how they come out I think will also define just how serious this recession is or isn`t going forward.`

Hoenig is of the view that the Fed has done as much as it can, with the central bank maintaining a very accommodative monetary policy and ensuring that there are excess reserves in the system. He blamed the banks for not being able to lend due to their own capital constraints, thereby resulting in excess reserve building.

Countering criticism that the Treasury and the Federal Reserve have no clear plan for the $700 billion rescue package, Hoenig said that there is a plan, which is evolving. The Kansas Fed President also said he is concerned about lending to non-banks, as the lending necessitates additional supervision into these institutions and interference with the natural incentives of the market.

Hoenig said, `I think there should be a bright line between banking and commerce so that you don`t extend that to an ever larger group of institutions that will bring forward then increased interference into the market, I think a very strong temptation towards credit allocation into the economy and those are all dangers that we want to avoid.`

Earlier last week, the Treasury had suggested that it may not stick to its original proposal to buy tarnished debts from banks. Companies seeking assistance from the government may be asked to raise private capital in order for them to qualify for public assistance. Treasury Secretary Henry Paulson also said that under the Troubled Assets Relief Plan, the government would attempt to attract private capital, potentially through matching investments. The Treasury also said it would consider the needs of non-banking financial institutions not eligible for the current capital program.

In the interview, Hoenig avoided a direct question on whether it is appropriate to lend to General Motors (GM) or bail it out. Hoenig said it is up to the government to decide as that is more of a fiscal issue. The Fed President also sees moral hazard in bailing out consumers. He called on supporting the right people who can afford to own a home. Noting that there are about 10-11 months of inventories, Hoenig said he expects 18-24 months before inventory begins to work down. It is only after that a turnaround is likely.

Hoenig focuses on consumer confidence, employment numbers and business investment as areas that could help determine as to when the economy could turn around. Globally, any move to restrict trade to protect could also spell trouble.
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