Collapses create nervous consumers, risking a deep recession

Are we in a period more like the stock market crash of 1987 or — gulp — the crash of 1929?

That’s the impromptu debate that Jared Faellaci said developed during a recent business meeting with clients and colleagues.

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M. SPENCER GREEN/Associated Press

Big drops this week in the Dow drew comparisons to the market crash of 1987 and even the crash of 1929 that launched the Great Depression.

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“I’m in the middle,” Faellaci, a 36-year-old business development manager with accounting firm Deloitte, said last week after a flight to Atlanta. He still sees some “positives” in the economy, but clients are cutting their spending and Wall Street is increasingly looking like “a house of cards that was overinflated,” said Faellaci, who lives in Dothan, Ala.

“This thing could get really ugly,” he fears.

Such fears are no longer idle water-cooler talk. If the seemingly nonstop pageant of takeovers and collapses of big financial institutions causes widespread anxiety, such pessimism could lead to a deeper recession, assuming the U.S. is already in one as some economists believe. By causing consumers, who represent more than two-thirds of the economy, to cut back spending, corporate profits would decline further. That, in turn, could aggravate an already skittish Wall Street.

Late in the week, the federal government was crafting a plan to stabilize the financial markets by perhaps creating an agency to absorb financial institutions’ toxic assets in a move that could cost taxpayers hundreds of billions of dollars.

The step follows multiple crises over the past two weeks in which the federal government has bailed out mortgage financiers Fannie Mae and Freddie Mac and insurance giant AIG, while broker Lehman Brothers filed bankruptcy and Bank of America bought ailing Merrill Lynch, the nation’s largest broker. Meanwhile, central banks around the globe moved to pump more cash into their banking systems to keep crucial short-term loans between banks from drying up. Stock markets plunged amid the heightened fears. The Dow Jones industrial average fell 400-500 points on some days last week before rebounding on news that a more systematic bailout was being considered.

The government is trying to calm market and consumer fears that some say could snowball into a general panic and lead to a deep recession.

“I think we’ve been in [a recession] all calendar year,” Faellaci said, adding that he’s already seen a “tremendous impact” on his clients’ spending here and overseas. “We actually think it’s a global recession at this point.”

Mercer University economist Roger Tutterow worries that the weekly drumbeat of bad news is increasing such anxieties, but he figures that the financial crises have so far remained largely “Wall Street events” that haven’t affected most people across the country. “So far, what we’ve seen is most consumers have kept cool heads.”

Others worry that the turmoil on Wall Street could last another year or more and that the fallout will eventually affect consumers.

“Psychology is very important,” said Michele Garren, a portfolio manager at Invesco, an Atlanta-based investment management firm. “So far, the press has done a good job of not scaring people, but this is a very serious situation.”

Garren, who used to work for AIG, believes the federal government was smart to take over the insurance giant last week because its debt, insurance contracts and other financial securities “touched every type of institution that you could imagine.”

But more problems affecting other major financial institutions are likely to continue surfacing until depressed home prices — the original trigger for the rolling credit crisis — begin to recover, Garren said.

“Who’s going to buy those [houses] if banks aren’t lending?” Garren said. “I don’t see where the demand is coming from.”

Law professor Jack C. Williams, a bankruptcy expert at Georgia State University, likewise expects the turmoil on Wall Street to continue for another year or so.

“People are questioning the legitimacy, competence and goodwill of management” at ailing Wall Street firms that made bad bets on mortgage-backed securities and more exotic derivatives contracts tied to falling home values, Williams said.

When investors and trading partners lose faith in management teams at those companies, he added, the scene can resemble wolves picking off weak animals from a herd. A company’s market value “can dissipate in a short amount of time,” he said.

“I’m worried about the short-term fallout because of the lack of liquidity on a global basis,” said Williams, who expects to testify later this week at a congressional hearing on the crisis.

Still, like most of the experts interviewed, he said he doesn’t fear that the U.S. is vulnerable to tipping into a full-blown depression like the one that crippled the nation in the 1930s.

The nation is “not very vulnerable at all because we’ve got so [many] safeguards and mechanisms in place,” he said.

The crisis could eventually “filter into the real economy,” but it won’t likely cause consumers to panic, agreed Jon R. Moen, a University of Mississippi economics professor.

“I don’t know if we can talk ourselves into that much of a panic. … The average guy on the street isn’t going to run off and sell all these exotic derivatives because he doesn’t own any,” said Moen, who studied the Panic of 1907 when he worked as an economist at the Federal Reserve Bank of Atlanta in the late 1980s. (That panic caused widespread runs on banks, leading to the creation of the Federal Reserve.)

Still, a prolonged financial crisis threatens to hurt consumers’ outlooks if prices of stocks and houses remain depressed, said Tutterow, the Mercer University economist. He said that will tend to make them feel poorer and less likely to spend.

“That plays on their psyches, too,” he said. “The wealth effect cuts both ways.”

Indeed, Joe White, 52, said he’s playing it safe because high gasoline prices are eating into his buying power and the uncertainty on Wall Street is threatening his retirement savings.

“I’m not sure of the future. I think we’re in the process of establishing new norms,” said White, of Braselton, who is semiretired after recently selling a business that distributed commercial doorway security systems.

“The retirement account is the big issue,” he said. “I’ve basically put everything on hold.”

Meanwhile, he’s also traded in his seven-passenger van for a more fuel-efficient Honda CR-V, and he plans to start studying to launch another career as a real estate agent.

The real estate market will recover someday, he said. “I hope to hit it on the rebound.”

Tutterow believes home prices may soon bottom out. He forecasts that the U.S. economy is in a “mild contraction” that should begin to reverse by mid-2009.

That would be welcome news to Lorraine Elder, a first-time home buyer who expects to complete the purchase Wednesday, one day after her 63rd birthday.

But she’s worried, both about the big step and the state of the economy.

“I’m shaking in my boots,” said Elder, a homemaker in Carrollton. “I’m not ready for it. I don’t want this.” Her husband was very excited because they got a good price on the three-bedroom, two-bath house, she explained.

“I think we’re in a recession, with gasoline prices the way they are,” she said.

JUST HOW ‘WEAK’ IS IT?

Job losses, weak growth, inflation — the economy is struggling, whether or not economists eventually decide there is a recession. By most accounts, the economy has weakened.

But before we slip too deeply into despair, let’s compare the current picture with the worst economic periods of the past eight decades and see how we stack up. Or down.

— Michael E. Kanell

* Based on gross domestic product, using constant dollars.
** Change in Consumer Price Index for the year.

How it looks now

Sources: Bureau of Labor Statistics, Bureau of Economic Analysis, National Bureau of Economic Research