COMMERCE BANK ECONOMIC REVIEW - DECEMBER 2007

“A year of challenges comes to an end, leaving even more issues to be resolved.”

By Joel L. Naroff, Ph.D.

What a year it has been. We have had wild swings in economic growth, the rise of subprime foreclosures and credit crunches. I said 2007 would be a year of challenges, but little did I realize how many and how great they would be. In looking out toward 2008, the economic landscape looks just as bumpy.

The year started with the economy apparently losing most of its steam. Economic growth slowed dramatically, raising recession fears. But just as quickly, the “collapsing” economy turned and activity soared. Third quarter growth was the strongest in four years.

But then the subprime issue exploded. The housing bubble splattered all over the economic landscape. Mortgage defaults hit record highs and housing sales slumped to levels not seen in a decade. With few homes being sold, inventories skyrocketed and home prices started dropping sharply in many parts of the country. Developers, facing reality, slowed building. The housing market became a basket case.

The real estate problems have major implications for the economy. Falling home construction will slow growth and lead to layoffs in the construction industry. Households no longer have the home as a source of easy money. Declining home prices are sapping confidence. Consumer spending is likely to slow. 

But the major concern is the credit markets. Rising defaults have led to massive losses for financial firms. When losses mount, these firms tend to become very conservative. They don’t want to make another bad loan or buy another bad investment. As a result, credit is restricted and rates rise. The continuing credit crunch could restrain growth.

With all of these negative factors, is it possible to escape a recession in 2008? The answer is yes. First, the weak dollar has allowed U.S. firms to become much more competitive. They have reacted with gusto and exports have soared. Indeed, the huge gains in foreign sales have kept the economy going.

But the real key is the job market. So far, employment gains have held up. Yes, they were significantly less this year than in 2006, but firms have added to payrolls enough to keep the unemployment rate relatively low and wages rising fairly solidly.

Ultimately, it is jobs that determine consumer spending. If consumers are not worried about their positions they will spend. They might be less confident and consumption might not be great, but it could be enough that when coupled with continued solid export gains, the economy would escape falling into recession.

Although consumers will be the determinate of where the economy goes next year – they will have help. The Federal Reserve is cutting interest rates. Yes, the Fed has been somewhat cautious and it is not clear that all members fully appreciate the challenges facing the economy. Rates have dropped one full percentage point in the past three months and it would not be surprising if they are reduced another full percentage point over the next three months.

The first part of 2008 will tell the tale. Although the possibility of a recession is real, it can be avoided. We need job growth to continue at a decent pace. But if firms stop hiring, watch out. 

Joel L. Naroff, Ph.D., is Chief Economist for Commerce Bank. Commerce Bank, America’s Most Convenient Bank, is a leading financial services retailer with more than 450 convenient stores in New Jersey, New York, Connecticut, Pennsylvania, Delaware, Washington, DC, Maryland, Virginia and Southeast Florida. Commerce Bancorp (NYSE: CBH) is headquartered in Cherry Hill, NJ and has $50 billion in assets. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.