Consumers won't bail out economy

Banks aren't extending credit and consumers don't want it anyway. And this continuing decline means it will take longer for the economy to revive.

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By Tami Luhby, CNNMoney.com senior writer

301 Moved Permanently

301 Moved Permanently


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How has Wall Street responded to last year's collapse of Lehman Brothers?
  • Made significant changes
  • Some reform, but more needed
  • Business as usual
  • It's gotten worse

NEW YORK (CNNMoney.com) -- Don't look to consumers to spend their way to an economic recovery.

Just how stressed American consumers -- and their lenders -- feel was evident in the latest consumer credit report issued Tuesday by the Federal Reserve. The amount of credit outstanding fell by a record $21.6 billion in July, the sixth straight month of decline. This was about five times the amount economists predicted and the longest consecutive decline since 1991.

The drop was caused both by consumers pulling back on the amount of debt they are holding and by banks restricting the amount of credit they are extending. Though the report does not break down these figures, economists said both trends were occurring.

"Consumers are being encouraged to deleverage and they are being pushed in that direction," said Mark Vitner, senior economist with Wells Fargo.

Revolving credit fell by $6.1 billion as people increasingly kept their credit cards in their wallets. Non-revolving credit, such as car and student loans, dropped a record $15.4 billion.

The pullback in credit comes as banks continue keeping their lending standards high. Banks are also writing off a lot of bad loans, contributing to the drop in consumer credit levels, Vitner said. And to minimize their exposure to risky customers, they are reducing or canceling lines of credit.

A small silver lining can be found in the fact that the declines in credit card usage are leveling out, after peaking this spring, said Scott Hoyt, senior director of consumer economics at Moody's Economy.com.

Long road to recovery

While many economists believe the recession has ended, they say the road to recovery will be a long one.

Any economic growth in coming quarters will be largely due to the rebuilding of inventories, which were slashed earlier in the year.

The Cash for Clunkers program may provide a temporary boost in auto sales and financing, but it won't be enough to tip the scales, economists said. The back-to-school season was dismal for retailers, with August sales at stores open more than a year falling by 2.9% from a year ago, according to Thomson Reuters. The holiday season will likely be no better.

Consumers won't start spending again until the employment picture improves, which won't happen before 2010, many economists predict. The unemployment rate rose to 9.7% in August, as another 216,000 jobs were lost last month.

As long as the unemployment rate keeps rising, Americans will keep their spending in check.

"The economy will start recovering, but it is not going to look like it to the consumer for a while," Hoyt said.

Even when it comes back, consumer spending growth will be relatively slow, said Pierre Ellis, senior economist at Decision Economics.

Americans have seen their wealth decimated in the housing bust and global recession. Net worth plummeted by nearly 22% since mid-2007.

This does not bode well for the employment picture. If consumers aren't buying, companies won't be hiring.

"It looks like another jobless recovery," Ellis said. To top of page

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