Mortgage malaise may bring recession: Merrill

Merril is taking the lead on addressing the problems in the mortgage market. While many analysts are still bullish about the strength of the overall economy, Merril acknowledges that the impact of a credit crunch could be severe to the housing and stock markets. Stay Tuned!

NEW YORK (Reuters) - House prices could tumble 10 percent this year and force the United States into recession if a credit crunch taking shape in the mortgage market gathers steam, Merrill Lynch said in research notes this week.

If correct, the prospects of this scenario will prove troubling for equities investors, who could face a stock market decline of 30 percent or more as measured by the S&P 500 index (.SPX : Quote, Profile, Research), the brokerage said.

Merrill said the biggest concern is that tighter lending standards in the mortgage market, even if confined to lower-quality borrowers, will constrain overall housing demand and hamper recovery in the struggling housing market.

"It is not inconceivable (given what is happening now to mortgage originations) that we end up with something closer to a 10 percent decline in home prices this year," Merrill Lynch said.

Merrill said this alone would slow the economic expansion to a rate of about 1.5 percent to 1.75 percent this year, which it termed a "growth recession".

The traditional definition of a recession is two consecutive quarters of declining gross domestic product.

However, if the inflation-fighting Federal Reserve were to keep rates unchanged to contain price growth -- instead of cutting by 1 percentage point in the second half of 2007 as Merrill expects -- then this would put the probability of an outright recession in the second half at "very close to 100 percent".

In the past, moves by financial markets to price in some risk of a recession, without actually experiencing one, has led to an average drop in the S&P 500 of 16 percent in sell-offs lasting 13 weeks.

"But if we do end up seeing a recession, then it's game over: the historical record shows that the average decline in the S&P 500 is 34 percent and the average duration is 37 weeks - more than double the magnitude and triple the duration of classic non-recessionary correction," Merrill added.