Downturn Shows Up on Main Street

The Dow Jones industrial average had its steepest one-day percentage drop in almost a year. The blue chips fell 370 points, or 2.9 percent. (By Jin Lee -- Bloomberg News)

"The flagging of consumer spending is causing a reduction in orders and a reduction in freight," Bethune said.

The downturn's spread through the economy also means less credit is available. Monday, the Federal Reserve said its survey of senior loan officers indicated that banks are pulling back on loans for commercial and industrial businesses.

"Banks are recoiling, hoarding liquidity, and consumers are pulling back," Anderson said. "A lot of these service businesses are smaller companies on the front lines of the economy."

The Fed cut the short-term interest rate it controls by 1.25 percentage points in January to try to prevent that negative cycle from turning into a deep recession. The weak showing in the service sector made it more likely the Fed will cut the rate again when it meets March 18, economists said.

The Fed's action, combined with an expected fiscal stimulus package from Congress, could help keep the downturn from becoming a long, deep recession but is unlikely to affect the economy in the first few months of 2008, economists said, because it will take time to ripple through the economy.

Businesses surveyed for the report named only three commodities -- cheese, electronics, and wallboard -- that are getting cheaper, and cited 17 that are getting more expensive, including corn, copper wire and gasoline.

Coming after two weeks in which the stock market stabilized, the report prompted the sharpest sell-off in seven months. Money flooded into safe investments, driving down the yield on short-term government debt. The yield on two-year Treasury notes fell 0.15 percentage points, to 1.92 percent.

[Asian markets plunged Wednesday on Wall Street's news, the Associated Press reported. In Hong Kong, the benchmark index fell 5.4 percent, while Japan's Nikkei 225 index sank 3.8 percent.]

"There are fears that we're in the midst of a recession," said Jim Herrick, director of equity trading at Robert W. Baird. "And just how bad that is going to get is anyone's guess."

Investors are also increasingly worried about the fate of bond insurers such as Ambac Financial and MBIA, which are at risk of losing their AAA credit ratings. If that happens, it could lead to cuts in credit ratings at banks, which hold some of the shaky subprime-related securities that the bond insurers insured, Standard & Poor's said in a report yesterday. Fitch Ratings said yesterday that MBIA's rating is under review.

Treasury Secretary Henry M. Paulson Jr., testifying before a Senate committee yesterday, said that the economy would grow "at a slower pace than we have seen in recent years," and that "the risks are clearly to the downside."

Tse reported from New York.