Consumers Mope — but There's Hope

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Fewer people are buying houses — or the washers to go in them

Tuesday, we got bad news, and bad news.

The Conference Board reported that its Consumer Confidence Index dropped to 106.8 in February, down from an already lousy 115.7 in January. That's five consecutive monthly drops in the 5,000-family survey, and it tells us that on the whole, folks are glum and getting glummer about their near-term economic prospects. Which means they can't be counted on to prop up the economy with their open wallets.

And if that wasn't bad enough, new-homes sales plummeted by 10.9 percent in January, the biggest drop in seven years — meaning that despite cheaper interest rates, people don't feel like their future is bright enough to take out a mortgage on.

So how bad is it, and how long is it going to stay that way? TIME senior economics reporter Bernard Baumohl gets in the Fed's head and goes behind Tuesday's numbers. Based on what you see in these numbers, what's the economic picture right now?

Bernard Baumohl: These two reports are further evidence that the economy is sinking, and sinking at a somewhat surprising rate. The Fed lowered interest rates by a full point in January, which is the most Greenspan's ever done in a month. And yet neither the economy or the stock market has really responded. Clearly, both investors and consumers are very pessimistic about the future, which can be self-fulfilling. We could have a shrinking in this first quarter, and possibly in the second quarter as well. And that, by the classic definition, is a recession.

How worried is the Fed right now that it won't be able to turn things around?

BB: The Fed has to be concerned about finding some way to revive consumer confidence. Consumers have two ways of measuring their wealth: their 401Ks and their houses. If the markets stay flat, and the housing market is sagging — which is what we saw today, along with last week's report that existing home sales were also down — there's a chance that people will just stop spending, and that's the way a recession can last a while.

I think Tuesday's reports definitely increase the likelihood that Greenspan will cut rates again before the March 20 meeting, probably by 25 or 50 basis points (a quarter or half a percent). It's hard to say exactly — the Fed is still sorting through all the numbers to try and figure out where we are right now — but three weeks is too long to wait when confidence is this low. Greenspan doesn't want to look like he's behind the curve — not in the first year of a new administration, not when he didn't cut rates fast enough when Bush's father was in office.

What do consumers need to see before they start spending again?

BB: Consumers need to see two things: First, that the unemployment rate is stabilized, that they don't necessarily need to fear for their jobs. And that shouldn't be too big of a problem — I don't think unemployment is going to get much higher than 4.5 percent.

They also need to see that investors are expressing some confidence about the future profitability of companies. They need to see the markets start going back up. Look at the correlation between the ups and downs of the NASDAQ and retail sales over the past few years — it's astonishingly closely tied. With so much of people's wealth determined by the markets, the markets are now the best leading indicator not only of the economy but of consumer sentiment.

Is there hope?

BB: I think you have to look to the third and fourth quarters of this year. That's when all the downsizing and cost-cutting and slashing of excess inventory that companies have been doing this winter and spring should start to pay off. If oil prices come down to the mid-20s, which I think they will, then companies are going to start to return to profitability. They've been doing all the right things in terms of cutting costs, and if the Fed continues to do its role, it's going to start to show up in consumer confidence.

Right now, consumers are very nervous. Their investments are taking a beating, there are layoffs all over the newspapers, the value of their homes is going down. But if the Fed acts, and the broader market starts to pick up a little, you'd be surprised how quickly their outlook can turn around.