The Worst Is Yet To Come in the US Financial Crisis

Large U.S. Banks May Fail Amid Recession, Rogoff Says
By Shamim Adam

Aug. 19 (Bloomberg) -- Credit market turmoil has driven the U.S. into a recession and may topple some of the nation's biggest banks, said Kenneth Rogoff, former chief economist at the International Monetary Fund.

``The worst is yet to come in the U.S.,'' Rogoff said in an interview in Singapore today. ``The financial sector needs to shrink; I don't think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job.''

The U.S. housing slump has triggered more than $500 billion of credit market losses for banks globally and led to the collapse and sale of Bear Stearns Cos., the fifth-largest U.S. securities firm. Rogoff said the government should nationalize Fannie Mae and Freddie Mac, the nation's biggest mortgage-finance companies, which have lost more than 80 percent of market value this year.

Freddie Mac and Fannie Mae ``should have been closed down 10 years ago,'' he said. ``They need to be nationalized, the equity holders should lose all their money. Probably we need to guarantee the bonds, simply because the U.S. has led everyone into believing they would guarantee the bonds.''

...``The only way to put discipline into the system is to allow some companies to go bust,'' Rogoff said. ``You can't just have an industry where they make giant profits or they get bailed out.''

The world's largest economy is already in a recession, and the housing market will continue to deteriorate, Rogoff said. The U.S. slowdown will last into the second half of next year, he said, predicting a faster recovery in Europe and Asia.

The Federal Reserve, which has left its key interest rate at 2 percent after the most aggressive series of rate reductions in two decades, risks raising inflationary pressures, he said.

``Rates are too low,'' Rogoff said. ``They must realize we're going to get inflation if things stay where they are. They need to raise rates but I don't think they are going to because they're way too nervous.''

To contact the reporter on this story: Shamim Adam in Singapore at sadam2@bloomberg.net.