Stress test the consumer

July 6, 2009

Christopher Swann– Christopher Swann is a Reuters columnist. The views expressed are his own –

People can be divided into three classes, it has been said: the haves, the have-nots and the have-not-paid-for-what-they-haves. The prevalence of the third category may be the biggest single source of vulnerability for the U.S. recovery.

A stress test of the consumer could reveal more distressing results than the one conducted on the banking system.

Debt is at high levels — 130 percent of disposable income, or more than twice its peak in the late 1980s. A slide in net wealth has reduced the collateral Americans can draw upon for emergency loans. Finally, it is now harder to borrow money for new consumption or to roll over existing debt.

Like a compromised immune system, this weakness makes consumers extremely susceptible to further shocks. Traumatic as the recent bout of retail restraint may have felt, worse may be in store. After all, consumption rose by 18.5 percent in the seven years to 2008. So far it has only fallen back by less than 2 percent.

There are several potential mishaps that could swiftly undermine consumer spending and set the recovery back to square one.

Among the most likely problems would be a continued slide in house prices. Even on the conservative measures used by the Federal Reserve, the value of residential real estate has fallen 18 percent since 2006.

With signs of recovery still tentative, a further 10 percent slide is well within the realm of possibility — inflicting a further blow on the balance sheet and sense of well-being of American households. (If nervousness over swelling government debt pushes up bond yields, the outcome could be still worse.)

Homeowner’s equity, already down to 40 percent from close to 60 percent, would plunge to 35 percent. This would send household wealth down to its lowest level since the mid-1980s. While Americans can’t immediately rebuild the $12 billion of net worth lost over the past 2 years — equivalent to more than a year’s worth of consumption — further losses will heighten their sense of caution.

A second threat is also looking increasingly likely — wage cuts. Fifteen percent of employers surveyed by the Society for Human Resource Management reduced pay in the past six months, a threefold increase from earlier this year. It is no longer implausible to imagine nominal wages starting to decline on a nationwide basis.

The Employment Cost Index is already rising at its slowest rate since the early 1980s. Wage deflation would make it even harder for Americans to repay the $10.5 trillion of mortgage debt they hold or the $2.5 trillion of consumer credit.

Martha Olney, a professor at Berkeley, envisages disproportionate cuts in spending if wages dip. “For households that are paying 60 percent of their income in mortgage and credit payments a 10 percent pay cut does not mean a 10 percent fall in disposable income,” she says. “It’s a 25 percent fall.” This is the danger of leverage.

Even under a rosy scenario it could take years for American consumers to repair their finances. If the savings rate rises to 8 percent of disposable income — about $860 billion a year — it will now take four years for debt to return to its 2002 level. This steady drain alone is equivalent to almost 10 percent of consumer spending.

After such a substantial loss of wealth, Americans will be pressed to be even more frugal. Along the way American will be hyper-sensitive to any jolts from weaker than expected employment, house prices or financial markets.

Consumer spending may not merely stagnate as most economists expect. It could yet decline more sharply. And like the banks, consumers will almost certainly need more support from the central bank and government before this economic malaise is over.

26 comments

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Dear,Mr.Christopher,
Well and wish to hear the same from you.
I have derived very good knowledge about America!s present economic scenes.
You have divided people into three types.
After my intensive reading of world economics,pattern of living,spending by big majority, i am classifying into five-5 types of people.
1.The Haves,2.The Have not segments,3.The have-not-paid-for-what,4.Masks of Have-not,4.The Have,pretender to outside.6.
Hidden wealth creators.
America have not invented any,new,potential new discovery to this world.
Whatever they have,that all were made into their cash coffins.
Now, they have spent by so many entertainment channels,whereas, other nations had used Americans sufferings for their wakeup call or for their growth.

What makes this scenario even more frightening would be a return of the $4 gallon of gas of spring 2008 (5$ in CA?). I firmly believe that this was what started the meltdown.
Tripling the price of gas in 2 years caused what little cash the average consumer had left over to evaporate. So, if you were used to having 100 bucks to pay the minimum payments on your credit card, you no longer had that once your cars required an additional 200 bucks a month to fuel. So credit card payments got later & later, then house payments were missed. Those same people who were now in trouble stopped buying clothes & house furnishings because they could no longer get additional credit.
People couldn’t afford the McMansions they were living in, so they put them up for sale, but so did everyone else in the neighborhood, so the law of supply & demand kicked their butts.

And it all started with high gas prices.

Posted by Keith | Report as abusive

Good article; thought, based on observations based on actual data, is SO much more interesting than the rhetoric that passes as “news” in too much of the US media; let alone the “the free market will save us” babble.

I fear the truth is this: there is no way in friggin hell that things are “going back to the good old days” (re. consumer spending based on ever greater leverage) — ever!

Too much wealth has been destroyed, too many jobs lost, too many jobs destroyed, too many home foreclosures, to much reduction in spending already, and WAY too much !personal! debt (still!) … and as you so rightly point out, likely more of some or all of those to come!!

Would be interest to figure out: if US consumer spending is flat, at best, for next, say, 5 years, what will that mean to revenue and profits of companies? what will that then mean to their stock prices?!?

Once Wall Street wakes up that to the fact that being able to breath again and going back to anything *approaching* 2.45% CAGR (based on 18.5% in 7 years) on consumption are two different things(!!), it could be a rough October …

Posted by tim | Report as abusive

Were into a serious downdraft…this is no longer a recession, its a DEPRESSION for sure…

Posted by marvinMBA | Report as abusive

Excellent piece. Yes, the next sound we will all hear will be the other designer shoe dropping– the consumers paying for their Jimmy Choo’s.

Gas prices have absolutely nothing to do with the so-called recession. Consumers not living within their means are the greatest cause for the downturn. Blaming gasoline is no different than blaming credit card companies for their fee increases, or blaming mortgage companies for lending money to financially uneducated consumers who then want taxpayers to pay their mortgages. Thought for the day – If you can’t afford it by paying cash at the time of purchase, then you can’t afford it; don’t buy it. It works every single time and is very practical in today’s world. Therein lies the problem in America – people want to live way beyond their means. It has nothing whatsoever to do with gasoline. Actually, if gasoline would reach $6 per gallon, we would see a revitalization in the economy that would benefit everyone, save the auto makers and oil companies, but no one cares about those industries after a large portion of the bailout money somehow got funneled into bonuses and the rest of it was mysteriously lost.

Posted by Frank | Report as abusive

When the banks create credit out of thin air and loan it to us it’s like a thief coming into your house and stealing your money and then loaning it back to you on intrest. Don’t pay them back you own the banks nothing.

Posted by scam | Report as abusive

Solid article. Touches on the basics that for some reason continue to be underreported as if being a smart consumer is unAmerican.

Interesting (though not surprising) WSJ article:
(http://online.wsj.com/article/SB1246575 39489189043.html) zero money down has been more harmful than subprime – um. duh.

Why is there not more outcry that Amex gets TARP funds when consumer debt is about 20% of housing debt??

Posted by Rich | Report as abusive

Only one way out, create inflation, may take a little time to feed through but is coming.

Posted by Chris | Report as abusive

This is exactly what I have been thinking. Everyone I know is creeping around like night critters caught out in the open. Despite all of the self-serving babble about green shoots from the shell-shocked investor/owner classes, I don’t see how we’re ever going to get back to the “good old days” (read: debt fueled spending bubble.)

The funny thing about all of this is that my wife and I got our own personal bail-out in the form of refinancing our 30 year fixed rate 7.2% mortgage for a 4.5% 15 year fixed this April (dumb luck, really). We knocked 8 years off of our mortgage and the payments stayed the same. For us the house is not an investment, it’s where we live.

But, even with this bit of luck we’re being VERY careful. I’m down to two credit cards, my wife has one, and we never let the balance get beyond what we can pay off in three months. We’re saving like mad. After seeing what can happen to our money in the stock market and mutual funds (that’s not so funny at all), money in the bank is a very good feeling. Yeah I know, it’s not earning much interest, but I’d rather have it safe and sound where I can get at it in a hurry instead of waking up in the morning and seeing that half of it has gone into someone’s else’s pocket. American capitalism is a filthy racket.

Posted by Bob Foster | Report as abusive

I think Keith hit the nail on the head. High energy prices (mostly gasoline) were the proverbial straw that broke the camel’s back. The greedy oil companies jacked up the prices, based on the speculation run up of crude oil prices. The are again hosing us even though demand is flat and I can’t point fingers at Bush and his cronies. Obama has done nothing to stop speculation in the crude prices and nothing to reign in Big Oil… OBAMA, if I wanted more of the same I would have voted McCain….Getting hosed again and I am not happy..

Posted by roger ewing | Report as abusive

Frank, your wrong. Every big run up in energy prices, especially gasoline has caused recession every time. It was the biggest factor in the demise of the Soviet Union and Eastern Europe. Its right there in the history books. Yes many are living way beyond their means, but Keith’s scenario is right on. Frank must be an oil exec.

Posted by roger | Report as abusive

Frank’s right, except for one important point. Banks didn’t just make money available to financially undereducated consumers, they quite actively made tens of thousands of loans to people who had no possible means to pay the money back. There is no question that irresponsible consumer behavior is to blame for our downfall. Yet so is irrational and irresponsible corporate behavior, and so too is irresponsible government behavior both in terms of out-of-control spending and more importantly in the elimination of good and useful regulation such as Glass-Steagall, capital requirements for banks, and so forth.

Blaming consumers alone fits a political agenda but does not fit reality.

Posted by Jonathan | Report as abusive

You highlight the effects but not the causes of lagging wages. Immigration brings in 1 million new US citizens each year. I suggest we halt all immigration temporarily.

Why pile more unemployed on top of a sinking life-raft?

Posted by Idealist | Report as abusive

This article is right on the money, but also fails to emphasize that people must take responsibility for their own actions. As a formerly middle class person (my income has not improved in the past six years), I have seen the incredibly naive people who because of their ridiculous credit card debt take money out of the equity of their homes to pay them off. It isn’t the fancy shoes, or even the designer clothes, but just ordinary going out to eat, buying on home shopping club, pampering ones self with nails, and whatever. Malls have capitalized on this stuff. And everyone has to “have” a flat screen TV. The haves never worry about the price of the object, they just buy. When I was a child, we saved up for treats, we didn’t charge them. We had nickel and dime savers in school that showed us saving was a worthwhile thing and encouraged us to do that. Wage variations and job losses are a part of life, and recessions happen throughout history. When people succumb to advertisers gimmicks (banks, credit card companies) then we have problems. At one point I had so many solicitations for credit cards I cut them up and sent them back in the prepaid envelop. Lets spend some more time teaching people how to money manage and stronger self-determination to be more than just a shill for the credit card companies. As I used to tell my students, the credit card is just a way to help the rich get richer. It does nothing for the little guy.

Posted by Elise Beaulieu | Report as abusive

For my deep inner thinking, from India and other Asian nations,very difficult to get entry to America for any jobs,for sight seeing,for any ordinary education to U.S.A.
One thing i can not understand that,how many African states people had migrated to U.S.A. for ordinary living and joining with their fellow beings for permanent stay.
If i want to go to America,generally,either I should be highly qualified,well earned brackets,for business promotions,or sponsorship, or from any important purposes-are all criteria for America!s visit.
I am not against to anybody.
I am a man of liberal views,supporter equality to all,irrespective of any religion,race,color,ethnic,are from any areas.
Due to over migration,-unless and until necessary for nation building,then only America will progress by her own methods.

I knew this was coming, many people would buy second homes in the Southern United States, West coast, locals made lots of money on dumb people, most wealth now is most southern states.

The young generation are much more aware, the 1980′s 1990′s generation is the Spend Generation. Most people in their 20-30 are better off then their parents. Most forclosed homes are people that are 45-50-60.

Posted by Ian | Report as abusive

“There are several potential mishaps that could swiftly undermine consumer spending and set the recovery back to square one.” Chris, I think you’re a little late to notice, but the situation is already at a crisis stage. There’s no real recovery happening, and in case you hadn’t noticed, poor folks have been subsidizing the rich for a very long time. See: http://www.debtdeflation.com/blogs/

Posted by Gregman2 | Report as abusive

Oil companies are at it again – today I paid over $3/gallon. Auto companies deserve to go out of business if they can’t serve consumer interests by making alternative fueled cars, instead of serving big oil which we all know is going to dry up before long. Efficiency of the workforce has increased exponentially due to technological advances and the profit has gone only to those at the top. Wages for working people hve not increased in the last 25 years. Even though their contribution is creating much greater profits, their buying power is greatly diminished since the price of everything has also increased exponentially – especially the cost of owning one’s own home – a basic necessity. When did consumers become the enemy to be sucked dry? Last I knew, we were a country of, by and for ‘the people’ – it seems we’ve become a country divided into the 1. Haves who want to scam even more away from everybody else; 2. Co-Dependents of the Haves who create the legislation or fail to enforce the law that allows the Haves profit from scamming everyone else; 3. Everyone else who still believe that we’re “one nation” seeking truth, justice and a peaceful, prosperous way of life for all… 4th of July celebrates our independence from exactly this kind of tyranny…what in the world has happened to America?!

Posted by alice | Report as abusive

What a lot of interesting comments – things in the UK are almost exactly the same – what a nightmare mess. People here were also sucked into living way beyond their means thinking their increasing house value would pay off their debts. The wickedness of the “city banker boys” no doubt saw them as fat stupid birds for the plucking and our Government let it go on because they were getting loads of tax revenue from the city spivs’ bonuses to squander on “public services”. It ain’t pretty – beam me up Scottie – if only!

Posted by Myfanwy | Report as abusive

The consumer is already stressed tested and now the bottom is falling out as this depression will be agrrevated by the government trying to bail us out with trillions of $$$’s………All the printed dollars that are piling up have no where to go (velocity) to get into the system if the jobless will not take out loans and start spending……I see DEFLATION Japanese style…America will feel this pain for decades….. for the Japanese are still able to go through this period because of individual savings…..American’s are just starting to save……It’s too late!!!

Posted by Mr. Anderson | Report as abusive

The sad fact is that the government’s stupidity, and the banking industry’s greed (well, everybody’s greed) has put us in this mess. Capitalism at its worst. Bank should never have given out loans to people who couldn’t afford to pay them back. It was insane. The trouble is that the idiots are now dragging everybody down with them. The banking industry across the globe should the same strict regulations (well, let’s hope they get some!). Alas, I see a lousy economic forecast ahead for the next several decades.

Posted by Elyse | Report as abusive

Naughty bankers may have exploited people who wanted to borrow more than they could afford to pay back, but that doesn’t absolve the people concerned from blame, nor, more importantly, does it get governments off the hook. For a generation now, governments have encouraged profligate borrowing because it allows them to claim that we’re all so much better off. What we’ve seen recently in the UK is the most extreme form of this: banks going under because of foolish lending and borrowing, introduced stringent conditions for new mortgages (25% deposit and so on). Very sensible on the face of it. NO! The government virtually ordered them to lend more! You couldn’t make this stuff up. We’re all in Never-never-land.

Posted by Matthew | Report as abusive

There are several fundamentally wrong things:

1. We cannot borrow our way out of debts. US is addicted to unsustainable way of life. People consume more than they can afford and cover deficit by borrowing against future income and assets. Finally we exhausted all reserves and… Government jumps in borrowing on our behalf put us as nation deeper into debts.

2. US pumps money to people/institutions who just prove that they cannot manage their money. At the same time government is taxing people who have proved that they can manage money.

3. US didn’t charge people who were at root of wrong decisions that affected whole society (AIG/Citi/Lehman/Bear/etc).

4. Gov overlooked second cause behind recent problems – Failing corporate governance. CEOs have heavy sway over corporate boards and rule unchecked. Instead of persuade interests of shareholders and public they play power brokers between unions/board/politicians and pocket unjustified compensations.

5. I am 39. There is no way current system can provide me with decent retirement.

Posted by Sergey | Report as abusive

What about the don’t wants ?

Posted by bloke nouvo | Report as abusive

Unfortunately, today we face the effects. Jobs are being lost. What was once a two income household is now a one or no income household? Granted many of us have borrowed against future income and now it is difficult or impossible to repay that loan. Many will make mortgage and car payment while buying food and what clothing is necessary and the rest will go by the wayside. The rest will just hope they don’t take home and car to soon. It is sad.

Now for anyone to state that Gas prices didn’t contribute to the collapse get off you bicycle and try driving to work. I would love to get off of gas and onto a better more economical and efficient mode of transportation but the auto industry has done nothing since the last oil crisis in the 70s to bring the internal combustion engine to its fullest potential or put out a viable alternative to the gas guzzlers. What do they give us but toy cars like the Volt and crap like the hybrid? No we should not have bailed out the auto industry. They have brought this debacle unto themselves. I would have loved to see new blood come out and take over our auto industry.

The consumer is always the ultimate payer. We pay while our voice is silent in Congress. We pay while CEOs are paid 100 times their worth. We pay as our retirement funds are slashed in half and our government does absolutely nothing to bail us out. You could run a consumer stress test but, we would fail.

Posted by B.Free | Report as abusive