Has the Economic Crisis Wrought a Permanent Change in Consumers?

In the past year leverage has been one of the most overused terms in explaining the causes and ramifications of the economic crisis. It has been applied specially to the gearing of investment banks and hedge funds, now supposedly cured of their addiction to leverage. Excessive leverage has also been blamed for the inhibition of commercial bank lending by the billions of dollars of devalued asset-backed securities on their balance sheets. Less attention has been paid to the equally important consumer side of the leverage leger.

It has been a general presumption that the blame and the cure for restricted lending lies with the banks. Once the impaired securities are removed from their books, banks will be able to resume their normal business role, lending to consumers and businesses, creating money through their loans and letting the populace regain its debt fueled purchasing habits.

Purged of bad assets, banks could again extend credit to businesses and consumers who would invest and spend and return the economy to robust growth. The essential credit function of banks is unchanged, though perhaps subject to stricter standards than in the bubble years. The real question is not whether the banks will lend when their books are clear, they will, but will Americans borrow? Are the consumers' free spending ways just waiting for the resumption of credit?

Has the economic crisis wrought a permanent change in consumer attitudes? Will the old consumer complacency towards consumption and debt resume when the Federal stimulus check start arriving or job creation begins again? Or has this crisis changed the US economy by changing the outlook of the US consumer?

Long term changes to consumer attitudes are difficult to track, but there is some indication in retail sales and in consumer credit that this crisis has had an earlier and deeper effect on spending and consumer outlook than usually realized.

Consumer credit has been contracting since mid last year. Consumers have been deleveraging, paying down credit lines instead of spending. In December, consumer credit fell $6.6 billion. The majority of that reduction, $6.3 billon, was to revolving credit, essentially credit cards and lines of credit that can be utilized at the discretion of the borrower or consumer.

Nominal retail sales have been negative only since July of last year, except for February they were positive in the first half of 2008. It seemed that consumers had continued to spend freely despite the long running housing crisis and the steep fall in job creation almost until the banking crisis struck in September and October. Such apparent resilience in the face of an economy that had worsened steadily throughout the year might bode well for a return to normal spending once the extraordinary restraints of the credit crisis are removed.

However if one examines real retail sales, corrected for the effect of rising and falling prices, they tell a much less optimistic story. Real sales were static in the first half of 2008; the three monthly rises of 0.2% in March, April and May were negated by contractions of 0.5% in February and 0.8% in June when the current string of negative months began. In fact the negative monthly numbers are unbroken from August 2007, with the three exceptions above, and a flat January 2008. This is a much more cautious consumer than generally depicted. Bank credit has not been restricted since the late summer of 2007, that crunch started in earnest last fall, but the fall in real retail sales began a year earlier.

If and when bank lending is no longer contained by balance sheet problems and credit begins to flow again then those people who can afford new cars and homes, but have been unable to find credit, will purchase. These borrowers will have to meet the new stricter standards that banks have instituted. These standards must necessarily reduce the number of eligible borrowers for all types of credit.

The lax mortgage standards of the housing boom contributed much to the housing bubble by granting mortgage credit to folks who had little or no real chance of honoring the terms of the contract. That group of purchasers is now shut out of the market. The pool of potential home buyers, to take just one market, has been substantially reduced. What percentage this group was of the total pool of potential home buyers is difficult to tell. But what is certain is that all types of consumer credit now have much stricter standards. Consumer credit cannot return to pre-crash levels because the pool of eligible borrowers is now smaller. If consumer credit is now permanently tighter, consumer spending will be lower for the foreseeable future.

But the reduction in eligible borrowers is not the main factor depressing consumer spending.

Fear of unemployment is a much heavier burden for consumers. But even the stunning job losses in the fourth quarter are not the whole story for consumer planning. The unusual and desperate circumstances of the credit freeze last fall, the failure of Lehman (LEHMQ.PK) and disappearance of every major US investment bank, the national election, the gargantuan fiscal stimulus and President Obama's apocalyptic rhetoric make for an uneasy future even for the most determined optimists.

The recovery scenario for the US economy has consumer spending in its primary and profligate place. That reliably cheerful consumer is likely to have disappeared in the financial crisis as surely as Lehman Brothers and Bear Stearns.

Comments

[Tradememe:]

Permanent change in consumer attitudes toward debt could very well be a long lasting result of this crisis. And no amount of stimulus will be able to change that.

Feb 10 08:14 AM

[six:]

Finally someone with some perception of reality. This article is spot on, the American consumer will never be the same. You did forget to mention one important fact- the housing bust and the soon to be credit card bust have created millions with sub par credit that will not to be able to borrow at good rates (if at all) for a long period of time. This will also create a drag on consumer spending. The average American is about to get exactly what they deserve. After years of inane spending and credit the bill has come due. Me? I am 95% cash (day trading ONLY!!! in small short positions) and debt free. This is the greatest thing that hase ever happened to me. I love America!!!!!!!!

Feb 10 08:58 AM

[antiquary:]

It's true that those old enough to remember it will never forget it. Which means that its effects will be around for the next sixty years or so. On the other hand, I wonder whether the really profligate consumers weren't merely the icing on the cake. If nothing else, this crisis will have done us all a service by providing us with hard and fast numbers for future analysis so that we know what actually means what. For example, how much being visibly outcompeted by those using high leverage is worth being alarmed about.

Feb 10 09:07 AM

[patio:]

Fine article. The author only misses one key component, this is all happening in parallel another huge macro event, the aging of the boomers.
The economic shifts projected to occur in "normal" times were things like:
- downsizing of homes
- less spending
- less taxes paid
- etc.

The boomers, who have seen tremendous wealth loss, have no time to try and recover, they are out of the markets for the remainder of their lives. They really have no choice, they will hang on to what they have left.
Now they will not only downsize, they will downsize on steroids.
This huge demographic shift just adds to the perfect storm problems, and amplifies them furhter.

Feb 10 09:17 AM

[johnbee:]

Isn't it a crisis of confidence all along? The public's greedy demand for borrowing was fed by lending from the banks, greedy for profit by creating all sorts of instruments to enable increased leverage to meet demand with supposedly insured risk from the likes of AIG.
Something must have happened in around 2007, or even before, to reduce people's ability to be able to make their mortgage payments on time. Was it an increase in interest rates or taxes or something else?
One of the things I believe may well have contributed to it, possibly in totality, was the banks themselves by substantially putting up interest rates to those people they knew perfectly well were least able to afford it, so as to re-possess their houses for profit. This is one of the nastier side businesses to banking that doesn't get too much publicity. The stupidity of it is that if its overdone the collateral value of houses (which was based on demand with the availability of low interest money) immediately fell away when the market got increasingly flooded with houses and so had a knock on effect on mark to mark bank balance sheet valuations,
and so on bank lending generally, and so on industry and so on jobs.

So what is the remedy? Confidence will not be restored quickly.
There needs be a return to the wild West and survival of the fittest and the shooting of all bankers OR the banks must make amends. As the banks can't do this then the Government need step into their shoes. Not with the same lunatic spending as before but with a cautious lending to companies to keep them afloat and to enclourage new enterprise, or for new public spending to give jobs where they are most needed.
The sooner banks are restored as they were ten years ago and kept apart by law from the anti social cowboys and idiots running the investment banks the better. They can cosy up to their friends in the hedge funds and see if they can come up with some useful ideas to make money instead of manipulating markets to the point of collapse-
that is if they are not all lynched beforehand, as they deserve.

Feb 10 10:25 AM

[User 354338:]

Well.. This article has some good points.. But it misses a few also.. The worlds economy relies on extended credit and consumers spending money on the "extras".. If 80percent of America was forced to live within their means, there would be a large percentage of companies that would have to close their doors.. Thats equals even less jobs, less sales tax to government, less government jobs and a tighter economy.

Whether you want to admit it or not. The world depends on foolish, lavish spending. It depends on a family having 2 car payments, 6 credit cards, a unaffordable mortgage, frivilous spending at the malls 2 and 3 times a week. Its how companies stay in business, people keep their jobs, gm keeps cars rolling out of the factory and malls stay open..

Point is.. In order for the economy to "bounce" back, there is going to have to be more credit flowing and not less..

Feb 10 10:32 AM

[@TexasER:]

It seems clear that people have not only been spending beyond their means, but also well beyond their needs.

The between 1970 and 2004, the average American new home grew in size by 55%. (Roughly from 1500 sq ft to 2300 sq ft, according to the National Association of Home Builders). With bigger houses come all kinds of additional increased expenses…higher energy needs, more furnishings, more land (and by indirect proxy, longer commutes), higher taxes, more insurance, and the list goes on.

People are looking to cut their wasteful consumption. In 1970, most families didn’t think they needed three bathrooms. In 2004, they were sure they needed all three.

It seems relative changes in home sizes might be a good proxy for this “perceived need.” So if consumers’ perceived needs drop back to 1970 levels, that would be a drop of 35%. If consumer spending is 70% of US GDP, then you would expect real GDP to need to fall by about 24% from 2004 levels.

Just food for thought…no predictions here.

Feb 10 12:37 PM

[Midwest:]

I'd like to think the American consumer will be permanently changed by this crisis but I don't believe they will be.

I am in the middle of this crisis and a victim of it, too, as I was laid off for the first time in my life and from a six figure job, to boot. However, I was smart enough to move my 401K funds around in late 2007 and rode 2008 with a less than 1% drop in my 401Ks value. I was both smart enough to do that but not smart enough to avoid being a target due to my relatively high salary.

My family and I came to a tough conclusion in September of 2006 about our debt load and we took significant steps to consolidate and reduce our debt via a second mortgage and tearing up all but one credit card. Have our spending habits permanently changed? Or is it a temporary blip on the road back to stupid spending? I don't know yet as we have gotten in trouble twice before this and dug ourselves out, only to repeat the sins.

I would only venture this much of a guess about the American consumer and their spending- Only one small group has learned a permanent lesson and that group is a bunch of middle aged men that weren't listening to common sense for the last twenty years and who put their own hind ends in a sling for a third car and a vacation home (I have neither and never have had either) and got themselves caught in a bad way.

I think these people (me, among them) are now permanently changed. We cannot afford to make the same mistakes and to be exposed to such horrific changes to the economy while we get caught looking. We will start saving and be sure we have enough to cover our bills for six months the next time our heartless companies decide we're suddenly "too expensive" and show us the door.

We are not most of the people but we represent a significant portion of spenders and our decision to cut back will be felt across the board.

The twenty somethings will barely remember this meltdown. Their peak earning years are 20 years away and in a much better time for the economy (I hope) so they will likely repeat the same mistakes I have made. The thirty somethings are going to smell the smoke but survive with some extra insight into their own mortality but likely to not change their spending habits.

In other words, most consumers will blindly buy the stuff they don't need once they feel comfortable in their jobs and finances. Permanent change is not ever going to happen to the American consumer, or any other consumer in the world for that matter. Once things get better, it will be like this never happened.

Feb 11 06:05 PM