COMMERCE BANK ECONOMIC REVIEW - OCTOBER 2007

“The consumer versus subprime: The battle is on.”

By Joel L. Naroff, Ph.D.

While the focus of attention remains largely on the subprime problems and the faltering housing sector, it has begun to shift back to the consumer. The extensive use of imaginative mortgage products to put people into homes who couldn’t afford those homes was a major driving force in the economy. But the economy still seems to be growing, even if it is only sluggishly. To sustain the expansion, consumers will have to keep emptying their wallets and it is not clear yet to what extent that will happen. 

With the credit crunch having hit in August, worries abounded that the economy could tumble. Those concerns were magnified by the August employment report, which initially indicated that firms cut payrolls. The first job decline in four years was a shock and ultimately led to the Federal Reserve reducing the funds rate by 50 basis points in mid-September. 

But then we discovered that the Bureau of Labor Statistics had some trouble counting. The August payroll decline of 4,000 turned into an 89,000 increase. July’s soft job data was revised upward as well. The private sector is still adding workers. However, the gains may be enough to keep the economy going, but they clearly do not indicate that firms are hiring like crazy.

So, what state is the economy in? The data do seem to point to us skirting a recession.  Job and income growth are decent enough to generate at least mediocre spending. But we have yet to see the price increases that will ultimately come from the $80-a-barrel oil. 

In addition, the housing market continues to spiral downward, and falling home prices will likely further slow spending. This is a process not an event. There isn’t just one month of problems. Instead, we will continue to see a flow of defaults over the months to come and that likely will cause home prices to fall further. Weak housing conditions rarely cause consumers to go out and spend. 

At this time of year, gauging household spending means forecasting the holiday shopping season. Many analysts are worried that it could be less than hoped for, especially if job gains don’t hold up. Department stores seem to share that concern. We already are seeing early season discounts as retailers try to sell as much as they can, as soon as they can. That aggressive marketing approach could be a boon for households and might save the season.

As the consumer goes, so goes the economy and any half-decent holiday spending should keep the expansion on track. But strong growth just doesn’t look to be in the cards and that worries the Fed. The monetary authorities have indicated they are ready to move as needed. What could get us another cut in interest rates are signs that consumer demand is fading. 

Additional rate cuts would be welcomed. It would lower short-term interest rates and that would make consumer loan products – home equity lines of credit and variable rate mortgages, for example – cheaper. Some credit card rates are linked to the prime and they too could decline. But it takes time for any Fed action to work its way through the economy, so don’t expect a major surge in growth anytime soon.

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 more than $48 billion in assets. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.