The Consumer and the Stock Market Storm

Will consumers stand fast or batten down the hatches? The health of the U.S. economy hangs in the balance

by David Bogoslaw

Only two months ago, the idea of crude oil falling below $100 a barrel and sharp drop in agricultural commodity prices would have seemed like a godsend to cash-strapped consumers. Gasoline and food prices have been slow to adjust to falling commodity prices, but that's probably not what is uppermost in consumers' minds right now. They may be more worried about their access to credit—and the health of the bank they stash their savings in—as the U.S. financial crisis has escalated in recent weeks.

With the defeat of the $700 billion financial rescue plan in the House of Representatives on Sept. 29, the fear now is that the longer the credit markets are forced to fester without a solution, the longer and deeper the economic recession the U.S. is likely soon to face. Congress is working on a revised version of the rescue bill, which is expected to pass within a week. But in a market environment where legendary institutions like Lehman Brothers disappear overnight, any financial-system rescue plan risks the patient expiring while waiting to be admitted to the emergency room.

Given the chill that has coursed through the credit system (BusinessWeek.com, 9/29/08), with banks denying requests for mortgage, home improvement, small business, and car loans left and right, it's not inconceivable that credit cards could be next. That would leave consumers with no source of cash except for their weekly paychecks, which in many cases are already pre-spent. Still unknown is to what extent the stability of credit cards may be affected by a handful of big commercial banks going under, but certainly banks are becoming less willing to let consumers run up bigger balances on their cards, says David Lockwood, consumer insights director at London-based Mintel International Groupin Chicago.

High and Dry

"That could be the next little thing that impacts individual consumers," says Lockwood. "I don't have a sense of how quickly that could happen. It seems it could happen fairly soon." That, plus the more remote possibility of payroll checks stopping if companies that rely on short-term credit from banks to meet payroll requirements start getting turned down, would leave consumers high and dry.

Lockwood doesn't believe most consumers are even aware of the broader implications of the credit freeze or the reasons behind the legislative battle over a rescue plan, however. "They'll respond [to the failure of the rescue bill] like they do to all major financial and policy initiatives, which is with long glazed stares," he says. Consumers have no connection to what's going on except for how it might affect the security of their bank accounts, he adds.

That's not what Richard Curtin, director of Consumer Confidence Surveys at the University of Michigan's Survey Research Center, is seeing in recent respondent data, which interviewers collect throughout the month. According to Curtin, 150, or 10%, of the survey's 1,500 respondents over the past three months, have reported having trouble getting a loan.

Slump in Confidence

"In the last week, we found confidence in the economy and how [consumers] expected the economy to behave have declined significantly," he says. "There's some evidence consumers have paid attention to this and are concerned about this." Just how worried consumers are will be reflected in the October numbers that the University of Michigan releases next week.

T.J. Marta, economic and fixed income strategist for RBC Capital Markets (RY) in New York, worries that a negative feedback loop might be forming, where short-term funding problems at Wall Street firms start to spread to companies and municipalities, prompting them to cut their workforce, which would then compound the pressure on consumers whose stores of personal wealth and access to credit have already eroded. "Consumers begin to retrench. That feeds back into corporations investing less and even cutting back on employees, and then you've got yourself in the loop," he says. "It's like a forest fire, It has to burn itself out. It's very hard to short-circuit these things. My fear with this bailout is it could psychologically unhinge the credit markets that are already very fragile."

While some sentiment indicators show signs of consumer confidence bottoming, that doesn't necessarily promise a rebound to healthy levels anytime soon, says Marta. "We could stay at the bottom for quite a while depending on what goes on with the financial situation," he says.