Friday, October 17, 2008

Consumers are gloomy because of recession, and NOT the credit bonanza of late!

When consumers get really gloomy, consumer confidence surveys tank, and the macro-economy is likely running cold. I have my issues with consumer confidence surveys, but as Tim Manni over at HSH Associates puts it (in his comment on my previous post), ”I will concur that consumer confidence does usually correlate with weak consumer spending and similar reports.” The ABC/Washington Post Consumer Confidence survey tells an interesting story: consumers are gloomy because the economy is in a recession, rather than banking system burning in flames - as many would say.

Here we are in the middle – or should I say depths – of a banking crisis. The Fed is dumping liquidity onto the U.S. economy from a B-1 Bomber, the Treasury attempts to re-capitalize ailing banks, and all the while, the economy proceeds with its cyclical downturn (recession). But what I really want to know is whether consumers extra gloomy because the economy is contracting, or because their 401k is at risk? TH, in a comment yesterday, seems to be wondering the same thing.

The headline consumer confidence surveys – U. of Michigan and the Conference Board – are monthly indicators, so I go to ABC for their high frequency, weekly confidence survey: Financial Crisis Sours Consumers; Record Say Economy's Getting Worse.

Well, it looks like even ABC got it wrong. Yes, consumers are melancholic and the consumer confidence survey – where 82% of consumers say the state of the economy has worsened – has hit record lows (what doesn’t hit a record low these days), but not because of the financial crisis. Consumers are sour because the economy is in a recession, as their financial woes improved long before the beginning of the crisis (Lehman's failure on 9/14/08).

Consumers are understandably gloomy: more than 700,000 jobs have been lost, unemployment has risen to 6.1% and is expected to ascend further, 0.0% real consumption growth means no new goodies, and gas prices surged throughout 2008 means probably fewer "goodies" and similar "gas". But confidence in personal finances has improved.

The chart breaks down the consumer confidence index into its three broad categories: state of the economy, personal finance, and consumer comfort (buying climate). Just as the economic data would suggest, 82% of consumers surveyed believe that the state of the economy has worsened over the last week, where 62% believe that the buying climate is thriftier from last week. However, there is no net change in confidence over personal finances (50% believe they have improved, while 50% believe they have worsened). And in fact, consumer confidence over personal finances has improved since Fannie and Freddie were taken over in early September.

This just doesn’t jive with the credit market freeze of late…or does it? Consumers – with a considerable share of their wealth tied up in their home – see financing their consumption stream based on wealth as more stable now since the value of their homes have been secured.

When the U.S. government put Fannie and Freddie under conservatorship, they explicitly guaranteed the health of the secondary mortgage market. With the assurance that banks can roll over debt with Fannie and Freddie, the availability of mortgage credit will if anything not fall too propitiously.

On the other hand, if Fannie and Freddie had failed, home buyers would leave the market as mortgage credit dried up and demand for housing would sink. The equilibrium in home values would fall to a permanently lower level, and destroy consumer welath.

The possible failure of Fannie Mae and Freddie Mac casued more consumer angst than did the failure of Washington Mutual, or any of the related crises over the last three weeks. The ABC poll is consistent with this notion. Interesting.

Rebecca Wilder

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