INDIANAPOLIS | The U.S. economy is in the midst of a "dramatic downturn" that likely will persist through most of 2009, Charles Evans, president of the Federal Reserve Bank of Chicago, said Friday.

"At this time it is very difficult to judge how long the downturn might last and how deep it ultimately will be," Evans told a luncheon crowd of state business leaders. "But given the magnitude of the problems that we face, we could see activity remaining quite sluggish through much of 2009."

Evans, speaking to the Economic Club of Indiana, said he expects the recovery to take hold more firmly in 2010 and 2011. He said he is hopeful financial markets will stabilize, leading to improved borrowing terms for households and businesses. But, he cautioned, "it likely will be a while before markets are functioning in a manner that we would characterize as smooth and efficient."

Evans, whose remarks drew a crowd of nearly 800 to the Indiana Convention Center in Indianapolis, heads one of the dozen regional reserve banks across the country. The Chicago Fed covers all of Iowa and most of Indiana, Illinois, Indiana Michigan and Wisconsin.

Stabilizing an inflated housing market that led the nation into turmoil, Evans said, will be a key challenge for President-elect Barack Obama. The collapse of risky mortgage-backed securities has led to a glut of unsold homes. And that in turn has made it difficult for Wall Street to price mortgage-related assets still in the market.

"Until we get some firmer feeling that (the housing) market is going to stabilize with known prices, that's going to continue to put pressure on financial markets as to the valuation of those mortgage-related assets," Evans said. "How we get some type of firming on that is going be a very, very big important issue, and it's going to take the best thinking that we have on that. I'm very hopeful about that, but it's a huge challenge."

Unemployment, which grew to a national average of 6.5 percent in October, is expect to rise to between 7.1 percent and 7.6 percent by the end of next year, Evans said. Most forecasts call for the jobless to stabilize between 5.5 percent and 6.5 percent by the end of 2011.