Consumers Cutback, GDP Contracts in Third Quarter, a Recession Call?

The U.S. economy shrank during the third quarter as consumers cut back on their spending by the largest amount in 28 years, underscored the terrible toll of the housing, credit and financial crises as well as sent the strongest signal the country has plunged into recession.

Real Gross Domestic Product (GDP) shrank at a 0.3 percent annual rate in the third quarter, the Commerce Department reported Thursday. The decline was the largest since the end of the last recession in late 2001.

The third-quarter figure isn’t the first decline in economic output since the credit crisis started last year. Revisions to 2007 gross domestic product, released in July, showed that the economy contracted at a 0.2 percent annual rate in last year’s fourth quarter.


Consumers Cutback

The economic deterioration reflected a sharp cutback by consumers, whose spending accounts for the largest portion of national economic activity. In the third quarter consumers ratcheted back their spending at a 3.1 percent pace, the first decline in 17 years. The cutback also marked the sharpest quarterly drop since the second quarter of 1980, or 28 years ago, when the country was fighting runaway inflation in the grip of recession.

Underscoring the strain faced by consumers, the report showed that Americans' disposable income fell at an annual rate of 8.7 percent in the third quarter, the largest quarterly drop on records dating back to 1947.

In addition to consumers, businesses cut back sharply in the third quarter. They cut spending on equipment and software at a 5.5 percent pace. Home builders slashed spending at a 19.1 percent pace, marking the 11th straight quarterly cut back, and fresh evidence of the depth of the housing slump.


A Recession Call?

Following the release of the third quarter GDP contraction, most economists are forecasting at least two more negative quarters. The expected contraction until next year would more than meet a classic definition of recession, which is two straight quarters of shrinking GDP that didn't happen in the last recession, in 2001.

Series adverse shocks would be reasonable to send an economy into recession. A collapse of the housing market, and dried up lending have produced the worst financial crisis to hit the country in more than 70 years. An oil shock as big as those of the 1970s has worsened the already battered economy.

The National Bureau of Economic Research (NBER), the panel of experts that determines when U.S. recessions begin and end, uses a broader definition to determine recessions than two quarters of contracting GDP. The committee follows five key indicators to define a recession, of which the two most important are GDP and employment. The finding is usually made well after the fact.

In 2001, the committee weighed in at the end of November to pinpoint the recession starting point to March, when employment started declining. That year, the first negative GDP number came at the end of October showing a 0.4 percent annualized GDP decline in the third quarter of 2001. The figure was since revised to show a 1.4 percent decline for the quarter, and government figures later showed a GDP decline in the first quarter of that year as well.

Going into the fourth quarter there were two major problems weighing on the broader economy: tight credit, the continued deterioration in the housing market, and rising unemployment. The clearer indications of recession have already brought down energy prices, and there are tentative signs of improvement in the credit markets.

However, the housing market is a problem that isn’t going away. Tight credit conditions, mounting job losses and a weaker economy are likely to continue putting pressure on home prices.

Unemployment is expected to rise from its current level of 6.1 percent. Disappearing jobs, falling incomes, battered nest eggs and retirement accounts, and falling home prices are likely to make consumers retrench even more.

The 1981-82 recession lasted 16 month in which the unemployment rate hit 10.8%. The 1990-91 recession ran eight months but was followed by weak credit conditions for years as banks sought to rebuild. And the 2001 recession also was mild in length but employment declines stretched for almost two years after the eight months recession ended.


Wall Street Reaction

U.S. stocks rallied Thursday, pushing the Dow Jones Industrial Average back above the 9,000 level, after the government said the economy shrank less than forecast in the third quarter. The Dow Jones Industrial Average gained 189.73 points, or 2.1 percent, to 9,180.69. The S&P 500 climbed 24 points, or 2.6 percent, to 954.09, while the Nasdaq Composite rose 41.31 points, or 2.5 percent, to 1,698.52.

On the following day the stock market ended higher, but it closed out a dire October with a worst month record in 21 years. The Dow Jones industrials ended the month down 14.1 percent, while the broader Standard & Poor's 500 index lost 16.9 percent during October as the stock market fell victim to investors' anguish over frozen credit markets and what looked like an inevitable recession.

Fed Slashed Rates to One Percent as Economy Deteriorating

The Federal Reserve on Wednesday lowered its target for overnight federal funds rates by a half point to 1.0 percent in effort to turn around the economy hit by financial crisis. The vote to lower the Fed funds rate was unanimous. The cut marked the second half-point reduction in the funds rate this month, after the last concerted cuts by the Fed and global central banks on October 8.

The Fed has now pushed rates back to a low last reached in June 2003, more than a year after the 2001 recession ended.


At the same time, the Fed lowered the discount rate, the interest it charges to make direct loans to banks, by a half-point to 1.25 percent. The discount rate has become increasingly important as the central bank has dramatically increased direct loans to banks in an effort to break the grip of the credit crisis.

At the same time, the central bank signaled that downside risks to growth remain, indicating that more rate cuts could come. Spreading economic weakness was lowering the risks that inflation would get out of control. The weakness has caused dramatic declines in the price of oil and other commodities.

Also Wednesday, China's central bank cut interest rates for the third time in six weeks, amid a worsening growth outlook for its export-dependent economy. Japanese authorities signaled they might cut rates. And Norway's central bank cut its benchmark interest rate for the second time in two weeks. The European Central Bank and the Bank of England are expected to follow next week.

The extraordinary financial market stress over the past month has put the economy at greater risk of a recession. The aggressive efforts by the Fed to cut rates and take other actions to unfreeze credit markets will keep the country from plunging into a prolonged and deep downturn.

Lower interest rates are expected to boost economic growth, because they reduce the cost of borrowing for businesses and consumers, giving them an incentive to start new projects or spend money. Lower rates also reduce the cost of funds for banks, which theoretically should make them more willing to lend.

While benchmark interest rates have fallen, other lending rates have been slower to respond. The credit crisis has sent a wave of risk aversion through the global financial system, which has caused many banks unwilling to lend even with cheaper access to funds. Banks have tightened lending standards sharply.

Stock market trading was more subdued on Wednesday with the Dow slipping into negative territory and closing at 74.16 points lower. The Dow had staged its second biggest point surge ever on Tuesday with the Dow Jones industrial average climbing by 889 points in anticipation of the Fed's action.

Chart: online.wsj.com

Blue-Chip Stocks Posted Second Biggest Point Gain

U.S. stocks blasted higher Tuesday afternoon, wiping away a week's worth of steep losses as bargain hunters flooded the market and investors expected for an interest-rate cut by the Federal Reserve on Wednesday. The market jumped despite of home prices record fall of 16.6 percent and a sharp drop in consumer confidence news early in the session.

The Dow Jones Industrial Average jumped 10.9percent or 889.59 points to settle at 9,065.36. That was its second-largest daily point gain ever, coming after the Dow’s 936 points jumped on Oct. 13.

Broader stock indexes also jumped Tuesday. The Standard & Poor's 500 index rose 91.59, or 10.79 percent, to 940.51, and the Nasdaq composite index rose 143.57, or 9.53 percent, to 1,649.47. The Russell 2000 index of smaller companies rose 34.15, or 7.62 percent, to 482.55.

The rally comes as stocks have been beaten down in the past six weeks over a freeze in the credit markets. Investors have worried about the economy's ability to avoid a severe downturn with loans more expensive and harder to obtain.

The massive advance still left the Dow down 36 percent from its Oct. 9, 2007, record close of 14,164.53. It has lost 20.6 percent since the Sept. 15 bankruptcy filing of Lehman Brothers Holdings Inc., the event led to almost dysfunction of financial system.

Home Prices Fall 20.3 Percent From June 2006 Peak

A closely watched gauge of U.S. home prices, the Case-Shiller Home Price 20-city index, dropped 1percent in August and fell a record 16.6percent from the previous year as the downturn in residential real estate prices continued, Standard & Poor published Tuesday. Prices have now fallen 20.3percent from their peak in June 2006.

Meanwhile, the S&P Case-Shiller Home Price 10-city index dropped 1.1 percent for in August and plunged a record 17.7 percent over the past year.

Over the past year, Phoenix and Las Vegas experienced the largest declines, down nearly 31percent in both cities. Prices fell the least in Dallas, down 2.7percent, and in Charlotte, N.C., down 2.8percent. No city showed a price gain during the last 12 months.

Home prices surged in 2003 through 2006, climbing by a cumulative 52percent, according to Case-Shiller. Since then, however, homeowners have given up half of the gains from earlier in the decade as the housing and credit bubbles burst.

Falling prices have eroded Americans' wealth, cutting into their ability to borrow against the equity in their homes or refinance their mortgages or sell for a profit. Millions of Americans now owe more on their homes than the homes are worth.


The plunge in home prices also led to massive losses in major banks which in turn triggered financial crisis that have rippled to around the globe.

U.S. Consumer Confidence At Lowest Level Ever

U.S. consumer confidence plunged in October to its all-time low as consumers badly hurt by the financial crisis, the Conference Board reported Tuesday.

The overall index of consumer confidence plunged by a massive 23.4 points in October from last month revised-reading of 61.4, to a new low of 38, the lowest reading ever recorded since the survey began in 1967.

The report was extremely awful, wiping out any optimism that had been gained as oil and fuel prices tumbled from this summer’s record highs.

Consumers are feeling the brunt of this recession and a significant deterioration in the job market. Household wealth has evaporated owing to plummet home prices and plunge in the stock market. In addition, consumers are struggling to finance their purchases because of ever-tightening lending standards

The pessimistic consumer confidence reading echoes forecasts that consumer spending will likely decline in the third and fourth quarter of this year. As a result, gross domestic is expected to decline at a steep rate in the final three months of this year. Consumer spending has driven more than two-thirds of U.S. economic growth.

Scary U.S. retail sales and economy; global markets sank

As shoppers cut back, U.S. retail sales fell 1.2 percent in September, the Commerce Department reported Wednesday. The 1.2 percent decline was the biggest in three years since August 2005 and was the first time sales had fallen three months in a row since early 1991.

Retail sales were down 1 percent compared with a year earlier, the first time sales had been down year-over-year since 2002. Sales were weak in almost all kinds of stores. Excluding the 3.8 percent drop in auto sales, retail sales fell 0.6 percent.

Retail sales represent about a third of final sales in the economy and about half of consumer spending. U.S. consumer spending had been the engine of U.S. and global growth for most of the decade, but high debt loads, falling home prices, rising energy prices, flat income growth and poor job prospects have taken their toll on the American consumer.

Federal Reserve snapshot showed Americans are spending less and manufacturing is slowing around the country. Fed Chairman Ben Bernanke, speaking in New York, warned that the economy was facing a "significant threat" from credit-market turmoil and said a recovery would not be swift even if aggressive government measures stabilized markets.


Global Market Sank

Scary retail sales report, worries about the economy, and Bernanke's downbeat economic assessment spooked equities markets, sending the Dow Jones industrials down a staggering 733 points Wednesday. The Dow ended the day down nearly 8 percent, its steepest drop since one week after Black Monday in 1987. The Dow has wiped out all but about 127 points of its record-shattering 936-point gain on Monday of this week.

The broad Standard and Poor's 500 Index plunged 9 percent, its worst one-day drop since the 1987 stock market crash.

The selling spree carried over to Asia, where stocks fell sharply Thursday. Japan's key stock index plummeted more than 11 percent, South Korean shares shed 9.25 percent, and Hong Kong's Hang Seng Index was down 4.8 percent.

Following Asia's lead, benchmarks in Britain, Germany and France slipped about 3 percent. Russia's RTS also fell.

Earlier this week, after governments around the world announced plans to use trillions of dollars to prop up banks, including a U.S. plan to buy about $250 billion in bank stocks. The market appeared to be turning around after the news, sending the Dow to its greatest daily point jump ever and its biggest one-day rally since 1933.

U.S. stocks continued sinking, Dow dived under 9,000

Marking one-year anniversary of record high, the Dow has lost 39.4 percent.

U.S. stocks stumbled again Thursday with the major indexes down for seventh consecutive days as credit worries continued to roil. The sell-off was exaggerated by news that a major credit ratings agency was considering cutting its rating on General Motors Corp.

The Dow Jones Industrial Average dropped 678.91 points, or 7.3 percent, closing at 8,579.19. This is for the first time the Dow sank under the 9,000 level since late August, 2003.

The S&P 500 fell 75.02 points, or 7.6 percent, to 909.92, while the Nasdaq Composite dropped 95.21 points, or 5.47 percent, to 1,645.12.

The declines marked the one-year anniversary of the closing highs of the Dow and the S&P. The Dow has lost 5,585 points, or 39.4 percent, since closing at 14,164.53 on Oct. 9, 2007. It's the worst decrease for the Dow since 1974. Over the nearly two-year bear market that ended in December 1974, the Dow lost 45 percent.

The S&P 500 is off 655 points, or 41.9 percent, since its record high of 1,565.15 on Oct. 9, 2007.

The federal fund rate cut Wednesday didn’t ease pressure on stocks.

Global central banks jointly cut interest rate to fight financial crisis

The world’s major central banks joined together to cut interest rates Wednesday to fight a spreading panic, which is endangering the flow of credit and the world’s economies. The Federal Reserve, European Central Bank and Bank of England cut interest rate by one-half percentage point. The move was joined by central banks in Canada, Switzerland, and Sweden and blessed by the Japanese, whose rates are already so low. Although the Fed didn’t mention China in its announcement, China cuts its benchmark one year lending rates by 0.27 percent and suspended the withholding tax on interest income.

These unprecedented coordinated interest cuts were taken after financial crisis spread around the globe and major world stock markets tumble on Monday. Lower rates may do little to cure the epidemic, but do help offset the unwelcome credit squeeze caused by banks reluctance to lend even to each other. Given central banks’ role as a lender of last resort the interest cut will lower bank borrowing costs e.g. those borrowing from the Fed’s discount window. That means home equity loans, credit cards and other floating-rate loans will become cheaper as they all fluctuate depending on what the central bank does.

The Fed actions

In these joined efforts, the U.S. Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1.5 percent. The slash took the rate to its lowest level in more than four years.

Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation.

Stocks dropped again

Despite of the Fed interest cut, the Dow Jones industrial average lost another 189 points, or 2 percent, to close at 9,258. It was the sixth straight day of losses for the Dow. The index has shed more than a third of its value, nearly 5,000 points, since its all-time high, set one year ago Thursday.

The day's losses were lighter; the Nasdaq composite index fell 0.83 percent and the Standard & Poor's 500 dropped 1.13 percent.

Chart: WSJ.com


Related story:
Global stock markets tumbled, Dow fell below 10,000 since 2004

U.S. job lost the worst in 5 years

Main Street was really hurting as the U.S. economy lost 159,000 jobs in September, the worst since March 2003, the Labor Department reported Friday. Job losses in September was more than double the cuts made just one month before and double the average monthly loss this year.

It was the ninth straight month of job losses. An astounding 760,000 jobs have disappeared so far this year, a critical signal the country may be reeling toward a deep and painful recession. The employment report is just the latest in a series of indicators showing that the economy was deteriorating rapidly as the third quarter progressed.

The Labor Department's report, released Friday, also showed that the nation's unemployment rate was 6.1 percent, up sharply from 4.7 percent a year ago. Over the last twelve months, the number of unemployed people has risen by 2.2 million to 9.5 million.

Chart: MarketWatch

Congress approved $700 billion bailout of financial industry

Congress approved a historic $700 billion government bailout of the battered financial industry on Friday. The final vote was 263-171 in the House, ended two weeks of uproar in Congress and on Wall Street. The bailout bill was quickly signed President Bush.

The approval marked a sharp turn from Monday, when the initial bailout bill was rejected by congress, largely by angry conservative Republicans.

Treasury Secretary Henry Paulson originated the bailout plan when he urged Congress to immediately give him almost unchecked legislative authority to take action in preventing the spread of economic turmoil. The plan was initially a three-page request for unlimited power to use $700 billion any way the administration saw fit to stabilize markets. When the bill was approved, it had swelled to more than 450 pages as negotiators added restrictions for the administration and sweeteners for anxious members of Congress.

Lawmakers added greater supervision over the $700 billion to the approved bill, including a process where Congress could vote to block half the money to protect taxpayers and steps to crack down on "golden parachutes" for corporate executives whose companies benefit from the bailout.


Financial markets expectation

The rescue bill that Congress finally passed will limit panic in the financial markets, since it gives the government vast new authority to remove toxic securities that have damaged and clogged the credit system and already brought down some of America's biggest companies. A consistent set of bailout rules will prevent the wild swings in the stock markets in September. With the feds stepping into the bloodbath, the bleeding should stop.

While there will probably be more bank failures, the bill makes it clear that depositors don't need to worry about their money. The bill raises the amount of deposits guaranteed by the FDIC from $100,000 to $250,000.

Although the bailout is supposed to ease the "credit crunch," it will probably be a while before relief reaches consumers when banks loosen consumer loans. For one thing, the government will focus first on freeing money for banks and businesses so they are able to keep their operations humming and meet payroll expenses.

Until banks recover from credit default losses, they are going to apply more stringent lending standards. Banks may still have to digest defaults on mortgages, car loans, and credit cards as default rates rise in a year a head.


Stocks market reaction

Congressional approval of the financial rescue plan did little to lift the stock markets from their growing gloominess over the obstacles still facing the economy. Wall Street ended an intensely volatile week with the Dow Jones industrials falling 157 points and the major indexes all suffering big losses.