Dec. 5 (Bloomberg) -- The pace of borrowing by U.S. consumers dropped in October for the second time in three months, led by a decline in financing for automobile purchases.

Consumer credit fell by $3.5 billion, or 1.6 percent at an annual rate, to $2.578 trillion, according to a Federal Reserve report released today in Washington. In September, credit increased by $6.7 billion, less than initially estimated.

Consumer spending slumped in October by the most in seven years as the recession deepened and banks restricted access to loans. Mounting job losses and a lack of credit indicate spending, which accounts for more than two-thirds of the economy, is likely to keep faltering after dropping last quarter at the sharpest pace since 1980.

“Consumers are fearful of the economic outlook, particularly the jobs climate, and they have turned off the spending spigots,” said Richard Yamarone, director of economic research at Argus Research Corp. in New York. “When you are fearful of losing your job, you don’t ring the cash registers and you certainly don’t buy a car.”

Economists forecast consumer credit would increase $2 billion in October, according to the median of estimates in a Bloomberg News survey. The Fed initially reported a $6.9 billion increase in consumer credit in September.

Non-revolving debt, including auto loans and mobile home loans, decreased by $3.4 billion in October, according to the Fed’s statistics. Revolving debt, such as credit cards, dropped by $182 million. The report doesn’t cover borrowing secured by real estate.

Spending Slump

The weakness in consumer spending continued into the fourth quarter as industry figures released yesterday showed November sales at retailers registered the worst monthly decline in almost four decades. The recession caused consumers to postpone shopping until the start of the holiday season.

“The outlook for the consumer has rarely been this bad,” Chris Rupkey, chief financial economist at Bank of Tokyo- Mitsubishi in New York, said before the report. “Even if they wanted credit, consumers without perfect credit scores are being turned away by credit-constrained banks and finance companies.”

U.S. companies slashed 533,000 workers from payrolls last month, the most since 1974, the Labor Department said today in Washington. The unemployment rate rose to 6.7 percent, the highest level since 1993.

Record Foreclosures

One in 10 American homeowners fell behind on mortgage payments or were in foreclosure during the third quarter, the Mortgage Bankers Association said in a report today. The share of mortgages 30 days or more overdue rose to 6.99 percent while loans already in foreclosure rose to 2.97 percent, both all-time highs in a survey that goes back 29 years.

Oppenheimer & Co. investment analyst Meredith Whitney said credit card companies will reduce lending by more than $2 trillion over the next 18 months. Lenders that may have difficulty raising capital and want to avoid losses from rising loan defaults are pulling in credit lines, Whitney said in a research note dated Nov. 30.

In the auto industry, October vehicle sales dropped 32 percent from the same month last year to the lowest level since January 1991, led by General Motors Corp.’s 45 percent slide, as reduced access to loans and the recession reduced traffic at dealer lots.

Ford Motor Co. reported a 30 percent drop in car and light- truck sales from a year earlier and Toyota Motor Corp.’s declined 23 percent. Honda Motor Co.’s slid 25 percent, Nissan Motor Co.’s were down 33 percent and Chrysler LLC’s fell 35 percent, according to industry statistics.

To contact the reporter on this story: Vincent Del Giudice in Washington vdelgiudice@bloomberg.net

Last Updated: December 5, 2008 15:25 EST