Tighter credit standards among mortgage lenders might lower American home prices by 10% this year and push the economy into recession if the Federal Reserve doesn’t respond by lowering interest rates, Merrill Lynch & Co. said in a report.

Merrill analyst David Rosenberg, who previously forecast the Fed would lower interest rates in the second half of 2007, said there are two possible scenarios. With a rate cut, economic growth would slow to about 1%. If rates are left unchanged, and housing prices fall 10%, the probability of a recession is “very close to 100 percent,” Mr. Rosenberg wrote.

“There could well be potentially significant further drags on home prices, construction activity and of course consumer spending,” he said in a March 13 note to investors.

New Century Financial Corp., the second-biggest subprime lender in America, and other mortgage companies are facing possible bankruptcy as the number of borrowers falling behind on payments has risen to a fouryear high. More than 20 subprime lenders have closed or sought buyers since the start of 2006 and bank regulators are pushing lenders to raise credit standards.

Former Federal Reserve Chairman Alan Greenspan told the Futures Industry Association today that he expects the subprime mortgage problems to spread to the rest of the U.S. economy.

“If prices go down, we will have problems — problems in the sense of spillover to other areas,” Mr. Greenspan said. While he hasn’t seen such spreading yet, “I expect to,” he said.

Declines in home prices would have an effect on everything from furniture and appliance sales to landscaping and the price of copper. That would drive unemployment above 5% by the end of the year and make an “outright recession” more likely unless the Federal Reserve cut benchmark interest rates by a full percentage point, Mr. Rosenberg said.

“It is not a small issue,” Mr. Greenspan said yesterday. “If we could wave a wand and prices go up 10%, the subprime mortgage problem would disappear.”

Profit for homebuilders has plunged in the last year as potential buyers first hesitated because interest rates rose, then because home prices were falling.

“I would’ve thought that it would’ve rebounded by now and I would’ve been dead wrong,” chief executive officer of the largest luxury American homebuilder, Robert Toll, said at a conference in Las Vegas.

Analysts at Credit Suisse Group, Switzerland’s second-biggest bank, said in a note to investors yesterday that stocks worldwide would weather a surge in American subprime loan defaults.

“The key to whether or not fears of an economic recession and a far more severe correction in equity markets materialize rests on the shape of the labor market and the corporate sector,” Credit Suisse said.

The Federal Reserve raised its benchmark rate to 5.25% in June, compared with an average target of 3.2% in 2005, a year when net new mortgage borrowing soared by a record $1 trillion.

Chairman Ben Bernanke has identified 1% to 2% as his preferred range for the inflation gauge most closely monitored by the central bank. The measure, which excludes food and energy costs, rose 2.3% in the 12 months to February.