Economy jolts into decline

With retailers bracing for a grim holiday buying season, the economy isn't just slowing; it's actually shrinking, the government confirmed Thursday. It reported that the nation's gross domestic product declined at an annual rate of 0.3 percent in the year's third quarter and consumers' disposable income took its biggest drop on record.

In simpler words, "The train went off the tracks," said Brian Bethune, economist at IHS global Insight.

Wall Street took comfort in the fact that it wasn't even worse. The Dow Jones industrials rose 190 points.

But economists say tougher times are still ahead. Believing consumers are cutting back even more right now, they predict a much larger economic decline -- anywhere from a 1 to 2 percent rate -- during the current October-December period. That would meet a classic definition of a recession -- two straight quarters of shrinking GDP.

Not that there's any real doubt now.

Clobbered by pink slips, shrinking nest eggs and falling home values -- consumers are holding ever tighter to their wallets. The new report said Americans' disposable income fell at an annual rate of 8.7 percent in the quarter, the largest in records dating back to 1947.

The dismal news came just days before the nation picks the next president. Whether Democrat Barack Obama or Republican John McCain wins the White House, he will inherit a deeply troubled economy and a record-high budget deficit that could cramp his spending plans.

Each side said the new figures supported its political case.

"The decline in GDP didn't happen by accident -- it is a direct result of the Bush administration's trickle down, Wall Street first, Main Street last policies that John McCain has embraced for the last eight years," Obama said. He pledged to provide tax relief to middle class families and help people facing foreclosure.

Pointing to the economy's sad state, Doug Holtz-Eakin, senior policy adviser for the McCain campaign, shot back that "Barack Obama would accelerate this dangerous course." McCain said his tax cuts, free-trade policies and help to struggling homeowners would help turn things around.

More than in recent recessions, consumers -- the lifeblood of the economy -- are bearing the brunt of the country's housing, banking and other ailments. The third-quarter decline in their spending was the first in 17 years, and the 3.1 percent annualized cutback was staggering -- the most since the spring of 1980 when the country was in the grip of what some call the worst downturn since the Great Depression.

Walloped by such a huge pullback, the economy toppled into negative territory.

The latest reading on GDP, which measures the value of all goods produced within the United States, showed a rapid turn from the 2.8 percent growth rate logged in the second quarter. The new figure was the worst since the 1.4 percent rate of decline in the third quarter of 2001, when the nation was suffering through its most recent recession.

Democrats on Capitol Hill are pushing for another economic stimulus package and are weighing whether to hold a lame duck session before the new president takes office.

Under attack from Democrats and Republicans alike, the White House defended giving billions of bailout dollars to banks that now are rewarding shareholders and executives -- or even buying other banks -- rather than making loans to consumers and businesses.

Ed Lazear, chairman of the Council of Economic Advisers, said the government is keeping close tabs on banks' use of the money, but he also said normal activities such as paying performance-related salaries or distributing dividends are allowed under the law Congress passed.

White House press secretary Dana Perino said that "not only rich people get dividend payments," which can form a significant portion of income for retirees and mutual funds.

A collapse of the housing market and locked-up lending have produced the worst financial crisis to hit the country in more than 70 years.

To cushion the fallout, the Fed slashed interest rates on Wednesday by half a percentage point to 1 percent, a level seen only once before in the last half century.

Fed Chairman Ben Bernanke has warned that the country's economic weakness could last for some time -- even if the government's unprecedented $700 billion financial bailout package and other steps do succeed in getting financial and credit markets to operate more normally.

"As of now, most forecasts indicate that we will experience a serious recession, perhaps comparable to the recession of the early 1980s, but nothing like the Great Depression," said Simon Johnson, former chief economist to the International Monetary Fund and senior fellow at the Peterson Institute for International Economics. During the 1980-1982 recession, unemployment topped 10 percent.

Other analysts, including Mark Zandi, chief economist at Moody's Economy.com, predicts the downturn will be much more severe than the 2001 and 1990-1991 recessions but not as bad -- in terms of unemployment or lost growth -- as the 1980s one.

The unemployment rate, now at 6.1 percent, could hit 8 percent or higher next year.

The Labor Department said Thursday that new claims for unemployment benefits last week held steady at 479,000, an elevated figure that continued to point to troubles in the jobs market.

In the third quarter, consumers cut back on purchases of cars, furniture, household appliances, clothes and almost everything else.

Businesses cut back, too, trimming spending on equipment and software at a 5.5 percent pace, the most since the first quarter of 2002. And home builders slashed spending at a 19.1 percent pace, marking the 11th straight quarterly cutback.

Slower growth for U.S. exports -- reflecting less demand from overseas buyers who are coping with their own economic problems -- also factored into the weak GDP report. Exports grew at a 5.9 percent pace in the third quarter, less than half the second quarter's 12.3 percent rate.