Obama inheriting crippled economy

WASHINGTON – One day after Barack Obama was elected the next U.S. president, the outgoing Bush administration detailed its plans to borrow a record $550 billion through the end of the year to back the financial bailout.

The Federal Reserve, meanwhile, said it will boost interest payments to banks as authorities battle the worst financial crisis in decades.

The Treasury Department said Wednesday it will sell $55 billion in bonds next week, part of a massive borrowing effort to cover the $700 billion bailout and a budget deficit that’s expected to hit a record of nearly $1 trillion next year.

The government’s surging financing needs are a stark reminder of the challenges awaiting Obama even as the current administration moves to implement its rescue program and the Fed fine-tunes its approach to the crisis.

The financial turmoil flared anew Wednesday with the Dow Jones industrial average plunging 486.01 points, or more than 5 percent, as investors absorbed more bad economic news.

The central bank said it will slightly boost the interest rates it pays banks on their required reserves and the excess reserves they choose to deposit with the Fed. The rescue bill authorized the central bank to start paying interest rates to commercial banks on the reserves. Policymakers hope the move will further bolster the banks’ reserves.

Treasury also gave Congress its first report on the operation of the bailout fund, detailing the $125 billion the government spent last week to buy stakes in nine of the country’s biggest banks. The bailout legislation requires Treasury to issue reports each time its spending passes a $50 billion marker.

Treasury Secretary Henry Paulson has pledged to work with Obama to ensure a smooth transition. Paulson has set up desks and phone lines at the department where Obama’s incoming Treasury team can work between now and the inauguration on Jan. 20.

In light of the crisis, Obama is expected to quickly name members of his economic team. Former Treasury Secretary Lawrence Summers, who served in the Clinton administration, and Timothy Geithner, president of the New York Federal Reserve Bank, are among the names being mentioned for Treasury secretary.

In another gloomy sign for the economy, the Institute for Supply Management, a trade group of purchasing executives, said its service sector index suffered a sharper-than-expected drop to 44.4 in October from 50.2 in September as hotels, construction firms and retailers saw business shrink. A reading below 50 signals contraction.

A manufacturing report issued Monday by the ISM showed the worst reading since 1982, when the country was near the end of a 16-month recession

The government said last week that the overall economy, as measured by the gross domestic product, fell at an annual rate of 0.3 percent in the July-September quarter, reflecting the biggest drop in consumer spending in 28 years. Analysts are forecasting that GDP will fall by an even larger amount of around 2 percent in the current quarter. That would meet the classic definition of a recession as two consecutive quarters of declining GDP.

Mark Zandi, chief economist at Moody’s Economy.com, said he thinks GDP will keep shrinking through the first half of next year, pushing the unemployment rate up to 8 percent before a solid rebound can begin.

Zandi expects this downturn to produce the most severe unemployment since the 1981-82 recession, when the jobless rate jumped to 10.8 percent, the highest since the 1930s.

“I think we are through the worst of the financial panic, but I expect the recession will last through next summer,” Zandi said.

Major bond trading firms are projecting that the government will need to borrow a record $1.4 trillion during the current budget year, which began Oct. 1.

But Zandi said he expects the borrowing costs to be closer to $2 trillion. He noted the size of the rescue program that needs to be financed and the likelihood that Obama and a Congress with larger Democratic majorities will pass a second economic stimulus program of between $150 billion and $300 billion.

In its financing announcement for the current quarter, Treasury said it was bringing back three-year notes and will sell them monthly to help cover the increased borrowing needs.