Economy Shows New Weak Spots
Consumer Spending Flattens in August

By Michael A. Fletcher and V. Dion Haynes
Washington Post Staff Writers
Tuesday, September 30, 2008

The evidence is mounting: The economy is in a steep slide.

Unemployment is at levels not seen in five years. Consumer spending is flat. Many of the sectors that have been fueling the tepid economic growth of the past year are beginning to flag. Exports are softening. Agricultural and other commodity prices are slipping.

The question is, how long will the slide last, and how deep will it go?

Congress's rejection yesterday of a $700 billion bailout for the nation's teetering financial system made such questions even more urgent. Lawmakers have to find an answer.

"They now need to get moving or you really will have a serious drop in national income," said Thomas Ferguson, a professor at the University of Massachusetts at Boston. "We don't have to rescue Wall Street, but we do have to get credit markets open. You can't run private enterprise economies without credit. Nothing will work without that."

Some economists worry that the nation is in danger of slipping into a self-perpetuating cycle of tight credit, diminished confidence, reduced spending and growing unemployment that will result in a prolonged period of economic stagnation. Even relative optimists say the nation is in for nearly another year of sluggish economic activity, before the housing market hits bottom and things pick up again.

"The economy is struggling, to say the least," said Josh Feinman, chief economist for DB Advisors, Deutsche Bank's institutional asset-management division. "This credit crunch that we have has a vise-like grip. The arteries of credit flowing to the economy are severely constricted, and we need to free them."

The government released more bad economic news yesterday: Consumer spending was up less than 0.1 percent in August, the worst performance since February. That came on top of data last week showing that orders of durable goods are down and sales of new homes are plummeting.

Meanwhile, tightening credit has made it harder and more expensive for many small businesses to borrow money, a process that many analysts say could accelerate with the turmoil on Wall Street.

Dee Smith, who runs a small contracting firm that renovates and sells homes in Charlotte, Mich., said a bank he has dealt with for more than a decade has decided to finance a smaller share of his projects. While the bank would once give him construction loans for 80 percent of a property's appraised value, it now will pony up only 75 percent. That might seem like small change, but Smith said it has shaken up his entire business.

Because he cannot afford to put out the extra cash, he said, he has laid off four of his six workers. Meanwhile, because of the slowdown in the housing market, he's been unable to sell three houses he has renovated. For now, he's renting them out.

"I'm just hanging on until things change," he said. "But I don't see that happening for two or three years."

Laura Richards said sales are down 10 percent at her two California Tortilla restaurants in Bowie and Annapolis. She said customers are buying small burritos instead of large ones and single burritos instead of combo meals. She said she's trying to attract customers with promotions -- letting children eat free on Thursday evenings, for instance.

Worse still, with banks tightening credit, she's been forced to put off expansion plans. "Any plans of opening new restaurants are on the back burner until we see what's going on on Wall Street," she said. "Originally, I said that five locations was a goal. Now I'm trying to manage my downside. It will take two to three years to get back to where I was a year ago."

Richards's problems are being felt across the fast food industry. GE Capital has stopped offering financing quotes for new restaurant franchisees, while Bank of America has refused to increase lending to McDonald's franchisees, according to the brokerage William Blair and Co. "While clearly other sources exist for franchisees' funding options, the recent pullbacks of two main lenders in the area are disconcerting, to say the least," analyst Sharon Zackfia wrote.

Although some corporations are sitting on large sums of cash -- and those with top bond ratings are enjoying favorable access to credit markets -- others are paying much more for short-term loans, if they can get them at all.

GMAC Financial Services has reduced its mortgage business and cut the number of U.S. auto leases it writes because of the high cost of borrowing money. "The cost of funds is atrocious right now," said Toni Simonetti, GMAC's vice president for global communications.

Bart Dzivi, a northern California lawyer representing financial institutions, said the financial system's problems will soon wash up on Main Street in a major way. It might take some time, he said, because the change is coming in waves. The first wave forced record numbers of homes into foreclosure; the second took down major financial institutions. The third wave, Dzivi said, will affect the well-off as their housing values decline. "They're not going to buy that second Mercedes," he said. "They won't take that vacation to Hawaii."

Many analysts say that the bailout that failed yesterday would slow -- not reverse -- the deterioration in the economy. Things will not correct themselves until the housing market rebounds, they say.

"The economy is in bad shape, but it is not because of the problems in the banking system, it is because of the housing crash," said Dean Baker, co-director of the Center for Economic and Policy Research, who thinks housing prices will fall well into 2009. "The bailout would have freed up some money. But I never saw a sea change even if it passed. It wasn't like suddenly we'd be flush with credit."

Staff writers Annys Shin and Ellen Nakashima contributed to this report.

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