Economic Recession, Consumer Depression

What's eating consumers? The latest numbers show that consumer confidence is close to 40-year lows, suggesting the economy is in worse shape now than in times that seemed far darker, like in the early 1980s, when inflation and unemployment both crept into double digits. Yet inflation—despite record gas prices—remains at a manageable 5 percent. And unemployment is a modest 5.5 percent.

So I asked Dan Ariely, a behavioral economist at Duke University and the author of Predictably Irrational, to help explain why a modest economic slowdown has produced such dismal public attitudes. Excerpts follow:

Why are consumers so gloomy even though the economy, by traditional measures, isn't all that bad? Is it $4 gas? Or falling home values? Or something else altogether?

I think there are three reasons. First, cars are very important to the American psyche. Think about James Dean and his motorcycle, "On the Road Again," and all that. The American psyche has associated freedom with cars, and now it costs a lot more just to use your car and get this feeling of freedom.

Second, bankers have told us for years, "Your house is your most important asset. You should stretch and buy as much house as you can." Now, it looks like they lied to us in terms of how much we should borrow. And they personally made money in the process!

Third, I think the American people are really losing trust in our institutions. Think about all the meltdowns. First, it was the Internet. Then, Enron. Then, a banking crisis. Then, housing. Now, oil. All of these disasters are coming relatively close to each other. To people, it seems like there's something incredibly wrong with the way markets and institutions operate. Bankers giving crazy loans to people who can't pay them back, then they turn around and sell the same mortgages to people who know even less about them. It's incredible. It's a new version of the Wild West, and it's causing incredible distrust in the markets and institutions.

So, is the gloomy outlook justified?

I think the psychology is justified. If you thought you lived in a world where you understood the forces at work, and all of a sudden you didn't understand what's going on, your trust in the system all of a sudden becomes pretty low. Bankers can give loans to people who don't deserve them... It's not a world we understand or can predict.

Yet a lot of people aren't really that bad off. For all the foreclosures, most homeowners are still doing OK, especially those who bought before the bubble. Gas is expensive, but other things are cheaper, and overall inflation isn't that bad.

In general, you are right, but I think these problems are signals. Going into the stock market, for example. We've been told for years that's where you should put your money for the best return, but it turns out that's not the best thing to do. People told us: Housing is the best investment we can make. It turns out not to be such a good deal—and not because of anything we did wrong. It's the bankers who went wild.

Right now, it's the oil crisis. We went into Iraq in 2003 partly because of oil. And then we see a rapid sequence of events like this, and we have no control over the price of oil. Even for people who are doing OK, the problem is their inability to know what's right and wrong, and know where the next hit is going to come from.

What about market forces? One way or another, the markets would correct themselves, even if it's ugly. Doesn't that give people any confidence? That sooner or later this will end?

The only force I think can bring back consumer trust is regulatory force. People talk about market corrections. OK, there will be some price reductions but still, there are all these crazy people who made these stupid decisions. And they're still part of the market forces! Without serious regulations, there are good reasons not to trust the system. And, on top of the people involved, it turns out some of these sophisticated financial products were too sophisticated. Even the bankers didn't understand them.

So when all of these meltdowns are over, will consumers end up scarred in some way?

I think so. If you look at some of our experiments with cheating, what happens is, when people are a step removed from cash, that makes it much easier for them to cheat. So, think about stock options, and some of these complex derivatives and other securities. They're many steps removed from actual cash, and I think that makes it easier for people to do bad things with them. They're using ambiguity to color reality in a way that suits them. This is why I think that most of these meltdowns come from these complex financial products.

Isn't healthy skepticism a good thing?

If we're overworried, it will create a huge deficit to the economy. Trust is an incredible lubricant to the economy, and erosion of trust is hugely important. Yet the level of trust in the United States is sliding.

Will this new mistrust change the way consumers actually behave? Or the way we spend money? It's not like there's some alternative economy where we can spend our money instead.

Over the long term, I think we'll end up less trusting, and this will play out in small bits. The next generation will be unlikely to invest in the stock market at the same level, for example. It's true that most people's financial lives have not been affected by all these events as much as the news suggests. And it's true that in some sense we're talking way too much about all of these issues. But, in another sense, we're not talking enough about the real problem, which is the erosion of trust.

Have we become a nation of whiners, like Phil Gramm said recently?

I don't think so. In some ways, we don't whine enough. When was the last big public demonstration? Or the last big public outcry? Yet these are issues that deserve an outcry. There ought to be consequences. People should get fired or go to jail. These are things that do deserve high-level attention.

Disclosure: none

Comments

[PastTense:]

Real inflation is much higher than 5%; the government is using phony numbers.

With peak oil happening, exploding health care costs, government deficits which are going to get much worse, baby boom retirement (underfunded Social Security...), the housing crisis I don't think consumers are gloomy enough considering how bad things are going to get.

2008 Jul 29 06:55 AM

[Joyful Alte...:]

And our government owes trillions that we're responsible for.

2008 Jul 29 08:22 AM

[User 201843:]

Indeed "erosion of trust "...
This is an excellent article that starts to go to the crux of the problem for all of us. Our subconsious and psychological feelings towards what is happening to us. Why we cant get a handle on things, or why is it that we are no longer the best and beautiful in the world. The Govt and all the way up to the Eecutive Office are a bunh of "slick money grabbing special interests" groups that start a war for oil and indeed look where it (price) is today. Disaster in the family makeup due to home that are no longer homes because they are "forclosed" by the banks that made the "slick" loans in the first place but sold the mortgage to a fund.
This is going to leave a long term mark in the minds ofe one and all.
And worst of all...............

It is far from over yet!

2008 Jul 29 08:39 AM

[pockyclips ...:]

I saw the Presidential spokesperson partially blame the record debt for 2008 on the fact that this administration took office in a recession. What a load of Texas sized B.S.! Up until last month, the "R" word wasn't used because the stock market hadn't declined the magical 20%. There are still people claiming that the mood of Wall Street put us in this funk. Perception is 9/10ths of the law.

An unfunded war and Uncle Sam's bottomless printing press put us in
this mess. It took us 7 years to get here, and it will take just as long to get out.

2008 Jul 29 09:06 AM

[deaverb:]

The largest problem, though, is the instability in companies for managers and employees alike. In our 24/7 world, even the best of companies are moving here there and everywhere (and I speak as an entrepreneur). Employees are tense. Result: contractors. Fewer and fewer employees are in stable positions--I think that accounts for a ton of the nervousness. Being a free agent is not what most people are good at--but many more must do.

2008 Jul 29 09:17 AM

[Joyful Alte...:]

Being an entrepreneur/contracto... agent myself, it would be a whole lot easier with single-payer universal health insurance. I have a lot of friends who'd prefer being on their own, but they need an employer; otherwise, they can't get health insurance for themselves (or a family member with preexisting condition) or can't afford $1,500/month.

And on the general topic, if you're carrying two mortgages because you haven't been able to sell your old house yet, and a client company's been sold to an outfit from India, and a 19-year-old you know who couldn't afford college has been killed in Iraq, and---well, we all have good reason to feel anxious.

2008 Jul 29 09:47 AM

[mcadoo3312:]

All comments are on spot. The American public has no clue how much real trouble we are in on a global scale. For some reason, this country thinks that we can continue to run up our debts - personal, corporate, and governmental - with no consequences. Well, while our country has gone to the extreme of excess, other countries have been saving and profiting off our hubris. The tides are beginning to turn, but the people don't want to change. The "change" Obama is talking about is change from a former administration, but it is not the change our country needs to be sustainable in the future. When the sovereign wealth fund of Kuwait is $2 trillion, a low amount compared to that of Russia, UAE etc, and even more trillions of dollars are being held by other countries, we can be crushed if so desired. Instead of the narrow, short term focus that is driving this election, maybe we should be thinking more about how to keep the country solvent in ten years as opposed to keeping the thought of the "American Dream" alive. So that we do not become Japan, trying to solve this problem first is understandable, but earmarking billions of dollars onto bills is negating the progress that is trying to be made. The American public needs to get a clue and the American political system needs to worry more about the good of the country, not the good of the consituents that make up their party.

2008 Jul 29 09:54 AM

[deano:]

I don't think consumer confidence/depression is that hard to understand if you look at the picture beyond just the data, charts, etc. that have been documented to define the "economic situation". People are down for a lot of reasons, some of which only indirectly have some effect on the "economy":
- Total distrust in our elected politicians
- A war that goes on and on
- A deficit that is becoming enormous
- A country that is slipping in its values with each new generation
- A country that is no longer respected by most of the rest of the world
- Countries that appear to be poised to push the U.S. out of its leadership position in the world
- A negative savings rate in this country
- A lack of knowledge by the average investor in what to do to prepare for retirement
- Federal retirement programs that are totally unfunded
- Disappearing retirement programs from companies
- A dollar that is slipping into a black hole in value
- Home values that are dropping like a rock
- Mortgages that are upside down to the home values
- Medical costs that are sky-rocketing
- Educations programs that continue to get worse
- A country infrastructure that is falling apart
- A president that acted like he was a king and trampled on the constitution
- A gap between the upper and middle class that has been accelerating
- A financial world that is running out of control, demonstrated by the risky investment tools that keep appearing
- Jobs disappearing overseas
- Illegal immigration that is out of control and politicians who don't want to do anything about it
- Food and other imports with real safety and health problems that are coming through a network of inspections that is full of holes
- An automobile industry that appears to be disappearing and hasn't done anything to meet future requirements
- A total lack of a comprehensive energy bill or any organized strategy to get us off our dependence of oil

I know there are other things that citizens of this country are worried about that I haven't listed. I think you could take everything on this list back to some impact on the "economy", but if it isn't directly on the list of what the financial world uses to define "the economy", the talking heads in that world can only scratch their heads and say "What is everyone worried about? The economy is in fine shape." Do any of them really understand the big picture?

2008 Jul 29 02:08 PM

[kurt walter:]

Still waiting for 2 consecutive quarters of negative GDP. Holding my breathe.

2008 Jul 29 02:55 PM

[kurt walter:]

Record debt? As a percentage of GDP, the national debt is below the average for the past 50 years.... Oops.

2008 Jul 29 03:01 PM

[pockyclips ...:]

Percentages are like bungholes. Let's stick to real numbers.
10 trillion dollars debt/130 million taxpayers = apx $77,000
That's more than I and about 120 million taxpayers make in a year,
much less have in cash or liquid assets.

The guv'ment don't owe that debt, we do!

2008 Jul 29 03:53 PM

[Ames Tiedeman:]

I am not certain we will have two quarters of negative GDP growth. I think things are staying above water. The economy is actually not falling apart as one might suspect given housing and autos are in the tank.

2008 Jul 29 09:12 PM