So much for the idea that America could get away with a mild recession. Revised figures for the third-quarter show that GDP shrank by 0.5% at an annual rate, compared to the initial estimate of 0.3%, and worse is to come. Business investment and exports, which have hitherto propped up growth, are now heading for big declines, said Capital Economics, and households continue to retrench despite easing energy prices. In the third quarter consumer spending shrank at a 3.7% annual rate, a fall not seen since 1980.
Plunging house prices have made consumers feel poorer – and the negative wealth effect has some way to run. The S&P Case-Shiller housing index shows that in September prices fell by a record 17.4% year-on-year across 20 major cities. Tumbling house prices also mean that mortgage-equity withdrawals, which also fuelled consumption, have ground to a halt. The bottom line, said Nariman Behravesch of Global Insight, is that even with a massive stimulus programme, “we are in the early stages of one of the worst recessions” of the post-war period.
Fed tries to boost lending
With credit markets frozen, the government has enhanced its role as “lender of sole resort”, as Michael Mackenzie put it in the FT. The Fed will try to bring mortgage rates down and revive non-mortgage lending by buying $600bn of debt issued or backed by government-sponsored enterprises, such as Fannie Mae, and providing $200bn to the market for securities backed by student loans, car loans, credit-card debt and small business loans. This should reduce lenders’ funding costs, which should feed through to borrowers.
Will it work?
Rattled banks fearful of further losses are not in the mood to lend. David Rosenberg of Merrill Lynch notes that cash hoarding is on the rise, with the cash on banks’ balance sheets tripling over the past four weeks. Households are also hunkering down. Household debt and debt-service ratios are still near record highs, and Fed surveys show that demand for consumer credit and residential mortgages is near record lows. With demand for credit set to fall further as the economy shrinks, the Fed is “pushing on a string”, as Rosenberg put it. A repeat of the Japanese bust is looking ever more likely. As Rosenberg said, “we are just at the start of the deflation story”.