Katrina's aftermath worse than expected

Economic impact from storm could be much broader and more prolonged than originally thought.

September 2, 2005: 11:35 AM EDT

WASHINGTON (Reuters) - Hurricane Katrina's second wave -- soaring gasoline and home-heating prices -- may be less deadly and destructive than the storm itself but poses much greater risks to the world's biggest economy.

U.S. economic health is so dependent on keeping its increasingly indebted consumers shopping that another drain on their already-stretched budgets could batter the economy.

American consumers, whose spending on goods, services and houses accounted for 76 percent of the nation's total economy in the second quarter, have shrugged off many shocks over the past decade -- most notably the dot.com bubble burst of 2000 and the September 11, 2001 attacks.

They have done so largely by accumulating more and more relative cheap debts.

But economists worry that a fresh, even temporary, spike in energy costs as a result of damage to the Gulf region's oil infrastructure may be a shock too many.

"This is a very delicate moment," said Nouriel Roubini, economics professor at New York University. "The economy is already very imbalanced. On top of that, we've had a massive oil shock and now we have a natural disaster that might be something of a tipping point."

Whispers of recession
As the loss of life and scale of the damage to local housing and commercial infrastructure becomes clear, muttering of recession was not far from the lips of some economists.

Policy-makers insist, with some justification, that with economic growth well above 3 percent so far this year, talk of a nationwide contraction is far-fetched. Income and jobs are rising, corporate profits are high and inflation and long-term borrowing costs are low.

President Bush met with Federal Reserve Chairman Alan Greenspan on Thursday and, analysts reckon, will likely have heard that message from the central bank chief.

To be sure, the Gulf region will see a sudden sharp shock that will feel and look like one of the deepest recessions they have known.

Initial estimates of the cost of replacing insured property and goods in the area is as high as $26 billion, higher than the $22 billion of damage incurred by 1992's Hurricane Andrew -- America's costliest storm to date.

This huge bill has even more historical resonance when compared with the $32 billion of insured losses following the September 11, 2001 attacks. And total damage from Katrina, including uninsured items, could be as high as $40 billion, according to Merrill Lynch.

Yet, the most affected states -- Louisiana, Mississippi and Alabama -- account for less that 3 percent of overall gross domestic product (GDP), the broadest measure of the nation's economy.

And, despite the huge losses, reconstruction and rebuilding will most certainly boost activity sharply there by year-end.

Fuel fears
But with gasoline prices soaring and likely to remain above $3 a gallon and amid pre-winter fears of rising home heating costs, the timing of this regional catastrophe could have a massive ripple-effect.

If this new national energy shock -- crude oil prices had already doubled in 18 months prior to Katrina -- adds to growing fears of a housing bubble, rising short-term interest rates and swelling trade deficits, the nationwide horizon darkens significantly.

"The oil price impact will be the biggest for the national economy," economists at Goldman Sachs said in a research note.

Goldman estimates that average U.S. crude oil prices of $70 a barrel for September -- close to Friday's level of about $69 -- could force a rise of $50 billion to $60 billion in annual energy spending that would force cutbacks in other areas and knock half a percentage point off third-quarter GDP.

But they outlined a worst-case scenario of fuel rationing.

"Demand rationing, not seen in this country since 1979, would certainly lower consumer confidence and cause a much more widespread hit to the economy," they added, saying this could force the Fed to pause its campaign of raising interest rates. (For more on the Fed, click here).

Bush on Thursday urged Americans to not to buy gasoline if they do not need it but stopped short of raising the prospect of rationing.

Rationing or not, the soaring consumer oil bill remains be biggest national economic burden.

As the price of houses and equities held by many Americans continue to rise, families are saving nothing from their after-tax incomes and incurring greater debts to fuel seemingly insatiable consumption habits. Figures released on Thursday show the national household saving rate, at minus 0.6 percent, was the lowest on record -- falling negative for only the second time ever.

With household debt now up 60 percent in just five years, rising short-term interest rates will already be crimping wallets. Consumer mortgage interest payments alone were up 14 percent in the last year.

And, as with the devastation on the ground, poorer Americans will take a disproportionate hit from the energy price spike.

Consumer spending on gas, fuel oil and natural gas accounts for just 2.4 percent of the income of the richest fifth of households but 11.2 percent of the poorest fifth, said David Kelly, senior economic advisor at Putnam Investments

"Sadly, it is the poorest Americans in the regions and areas that have seen the weakest recovery from the recession of 2001 who are being hurt most by higher oil prices," he said