There is no doubt the U.S. economy is in a recession — and a very severe one — according to former Federal Reserve chairman Alan Greenspan.

“Gross domestic product in the United States in the fourth quarter is going to be down significantly,” Greenspan said at a Toronto luncheon on Friday.

He said monthly data shows that economic growth is sliding, and early October data appears particularly dire. “We know we’re going down and there’s very little we can do about that,” he said.

But early signs indicate that the worst of the financial crisis is beginning to pass, Greenspan said.

He suggests two key indicators will be critical in revealing when markets are beginning to stabilize: U.S. house prices, and global equity prices.

Home prices play a key role due to the vast amount of equity in homes in the United States, and the fact that much of this equity acts as collateral backing the entire international structure of mortgage-backed securities.

With the rate of liquidation of vacant, single-family homes starting to pick up rapidly, Greenspan said house prices should stabilize in the first half of next year. He also noted that the decline in U.S. house prices has begun to slow, but expects a further price decline of five to 10 percentage points before prices hit the floor.

The stabilization of home prices will correspondingly stabilize the prices of all the related mortgage-backed securities, Greenspan said, noting that there are still US$1.5 trillion worth of outstanding securities backed by pools of U.S. subprime mortgages. The home price stabilization will therefore help the widespread problems in the financial industry begin to thaw, he said.

“We have to stabilize prices and get that part of the problem solved,” he said, but he noted that this make take time. “We still have a way to go, it’s not something that’s around the corner.”

As for the role of equities, history shows that stock prices tend to lead economic recovery, Greenspan said.

“There comes a point when markets get exhausted on the downside,” he said. “That, to me, is going to be a very critical variable as to when we actually turn.”

Once stock prices stabilize, Greenspan said, people will again begin to seek riskier investments and the financial system will begin to recover.

On the topic of Canada, Greenspan said it is an unusual case of a country which has done everything right, but has been hurt by its exposure to the United States and the rest of the world.

“As well as you do things, if we don’t get it right, you’ve got a problem,” he said.

Given the strong state of Canadian financial institutions relative to others around the world, Greenspan advises Canadian institutions to take this opportunity to build up high levels of capital and stabilization. He encourages them to be cautious in expanding abroad in the current environment, given the unpredictability of global markets.

“Timing is critical,” he said.

As for the United States, Greenspan said there’s a positive way of looking at the current circumstances. The fact that 30-year mortgages are still yielding as low as they are, in spite of all the economic turmoil, indicates an underlying fiscal strength in the United States, he said.

“We’re showing the depth of the resilience of the American system,” he said.

Greenspan also pointed to the fact that the U.S. dollar continues to remain strong despite the state of the economy.

“With all of our problems, the dollar strengthened significantly because people sought that as a safe haven,” Greenspan said. He added that he does not expect a flight from the U.S. dollar, but said the country must be cautious in how it deals with the financial crisis to avoid driving away foreign capital.

IE