Tapped-out con­sumers re­dis­cover con­cept of thrift

The Washington Times Weekly - - National - BY DAVID M. DICK­SON

Af­ter spending much of this decade treat­ing their homes and stock port­fo­lios as their piggy banks, debt-bur­dened Amer­i­can house­holds are now des­per­ately beginning to save the old­fash­ioned way.

The per­sonal sav­ings rate has been ris­ing steeply this year as for­merly prof­li­gate con­sumers fran­ti­cally try to re­coup part of the $14 tril­lion in losses they suf­fered since mid-2007 from the bear mar­ket and the burst­ing of the hous­ing bub­ble. Many of the 78 mil­lion baby boomers are now re­vis­ing their re­tire­ment plans while fend­ing off fore­clo­sure, which has reached record lev­els as the un­em­ploy­ment rate soars.

What a dif­fer­ence a year makes. In April 2008, four months af­ter the re­ces­sion be­gan, Amer­i­cans were sav­ing none of their af­ter-tax in­comes. A year later, af­ter an ad­di­tional 5 mil­lion jobs were lost, af­ter home prices con­tin­ued to plum­met and af­ter the stock mar­ket re­cently hit a 12-year low, the sav­ings rate jumped to 5.7 per­cent in April — its high­est level in 14 years.

To gen­er­ate the sav­ings, con­sumers ratch­eted down their spending faster than their in­comes were fall­ing. Un­til the sec­ond half of last year, when con­sumer spending plunged at an an­nual rate of more than 4 per­cent, Amer­i­can house­holds had not re­duced their spending in any quar­ter since 1991.

Even through­out the 2001 re­ces­sion, con­sumer spending con­tin­ued to rise. Dur­ing the last six months of 2008, how­ever, con­sumer spending de­clined a record six months in a row.

The steep drop in con­sumer spending last year has con­trib­uted to the long­est, and per­haps steep­est, re­ces­sion since World War II.

An­a­lysts do not be­lieve the new-found thrift will be fleet­ing. As a re­sult, the eco­nomic re­cov­ery, which many economists ex­pect to be­gin dur­ing the sec­ond half of this year, will be more slug­gish.

“There has been a fun­da­men­tal shift in the be­hav­ior of Amer­i­can house­holds,” said Bernard Bau­mohl, chief global econ­o­mist for the Eco­nomic Out­look Group. He ex­pects the sav­ings rate will con­tinue ris­ing, even­tu­ally reach­ing 7 per­cent to 9 per­cent, where it will likely re­main for sev­eral years.

“Amer­i­cans have learned a cruel, cold, hard les­son. Peo­ple are scared. And that’s led them to re­plen­ish their sav­ings be­cause they now re­al­ize that their re­tire­ment nest eggs will no longer in­crease on au­to­matic pi­lot,” Mr. Bau­mohl said.

“The con­sumer mind-set has def­i­nitely changed,” agreed Scott Hoyt, se­nior di­rec­tor of con­sumer eco­nomics at Moody’s Econ­omy.com. “Their bal­ance sheets have been dec­i­mated, and they are heav­ily bur­dened with debt.”

Dur­ing the past 30 to 35 years, as Amer­i­cans saved less and less, con­sumer spending grew faster than the over­all econ­omy, Mr. Hoyt noted. Con­sump­tion, which ac­counted for 62 per­cent of gross do­mes­tic prod­uct (GDP) dur­ing the 1960s, com­prised 70 per­cent of gross do­mes­tic prod­uct dur­ing the 2000-2007 pe­riod. Mean­while, the per­sonal sav­ings rate, which av­er­aged 8.3 per­cent dur­ing the 1960s, av­er­aged a mere 1.5 per­cent of af­ter-tax in­come from 2000 through 2007. Dur­ing the 2005-2007 pe­riod, sav­ings av­er­aged just 0.6 per­cent, the low­est rate since the Great De­pres­sion.

Mr. Hoyt said con­sumer spending may grow slower than GDP dur­ing the next decade as house­holds try to re­plen­ish their sav­ings. As a re­sult, the re­cov­ery will be slower than it oth­er­wise would be as house­holds con­cen­trate on in­creas­ing their sav­ings and re­duc­ing their oner­ous debt bur­dens, Mr. Hoyt said.

“Many Amer­i­cans thought they were go­ing to meet their fi­nan­cial goals on the cheap as their home val­ues and 401(k)s soared. Now folks re­al­ize they are go­ing to have to do it the old-fash­ioned way — spend less, save more.”

Since the sum­mer of 2007, when the credit cri­sis erupted, the stock mar­ket neared its peak and home val­ues be­gan de­clin­ing in earnest, there has been an on­go­ing shock to house­hold wealth, said Mark Vit­ner, se­nior econ­o­mist at Wa­chovia Eco­nomics Group. Af­ter the re­ces­sion be­gan in De­cem­ber 2007, job losses have ham­mered house­hold in­come, ex­ac­er­bat­ing the wealth shock.

“Many Amer­i­cans thought they were go­ing to meet their fi­nan­cial goals on the cheap as their home val­ues and 401(k)s soared,” Mr. Vit­ner said. “Now folks re­al­ize they are go­ing to have to do it the old-fash­ioned way — spend less, save more.”

The shock to house­hold wealth has been ex­traor­di­nary.

From the mid­dle of 2007 through March of this year, the Fed­eral Re­serve es­ti­mates that house­hold net worth plunged $14 tril­lion, or 21.5 per­cent. Dur­ing the sec­ond half of 2008 alone, house­hold net wor th plum­meted nearly $8 tril­lion, in­clud­ing an un­prece­dented $4.9 tril­lion dip in the fourth quar­ter.

The broad-based Stan­dard & Poor’s 500-stock in­dex shed 57 per­cent of its value be­tween Oc­to­ber 2007 and March 2009. While the S&P 500 has in­creased 36 per­cent since its March low, it is still 41 per­cent be­low its 2007 peak.

From the beginning of 2000 through the mid­dle of 2006, U.S. home prices in­creased 93 per­cent, ac­cord­ing to the S&P/Case-Shiller Na­tional Home Price In­dex. In some mar­kets, such as Los An­ge­les and Mi­ami, home prices in­creased about 175 per­cent. Through­out this pe­riod, mil­lions of home­own­ers used their houses as ATM ma­chines by with­draw­ing eq­uity and us­ing the funds to fi­nance their con­sump­tion.

Since their peak in mid-2006, how­ever, na­tional home prices have plunged 32 per­cent. In some mar­kets, prices have plum­meted be­tween 40 per­cent and 55 per­cent. Peo­ple who pur­chased their homes when prices peaked or re­peat­edly re­fi­nanced their mortgages to tap their eq­uity have been hit es­pe­cially hard by the col­lapse of home prices. Moody’s Econ­omy.com es­ti­mates that nearly one in five home­own­ers is now un­der­wa­ter, mean­ing they owe more on their mortgages than their homes are worth.

Home prices will likely fall an­other 10 per­cent dur­ing the next year, said Guy Ce­cala, pub­lisher of In­side Mort­gage Fi­nance.

The col­lapse of home prices dec­i­mated the bal­ance sheets of banks and led to a tight­en­ing of lend­ing stan­dards. Most lenders now re­quire a 20 per­cent down pay­ment, Mr. Ce­cala said. That has pro­vided fur­ther in­cen­tive to save.

“Do the math,” Mr. Ce­cala said. “A $200,000 home with a 20 per­cent down pay­ment and $8,000 in clos­ing costs means that the pur­chaser will have to come up with nearly $50,000. We’re back to the days when buy­ers need to save,” Mr. Ce­cala said. “The 20 per­cent down pay- ment re­quire­ment, which isn’t go­ing away any­time soon, will be the big­gest ob­sta­cle for home buy­ers, es­pe­cially first-time home buy­ers.”

At 9.4 per­cent in May, the un­em­ploy­ment rate has reached its high­est level in more than 25 years, and it is ex­pected to con­tinue ris­ing through much of next year. Many economists project the un­em­ploy­ment rate will av­er­age more than 10 per­cent through­out next year. Work­ers who were not ac­cus­tomed to sav­ing in the past now ap­pre­ci­ate the need for a fi­nan­cial cush­ion in case they lose their jobs in the fu­ture.

Mr. Bau­mohl of the Eco­nomic Out­look Group fore­casts “the mother of all job­less re­cov­er­ies.” That’s say­ing a lot, con­sid­er­ing that the un­em­ploy­ment rate con­tin­ued to rise long af­ter the 1990-91 and 2001 re­ces­sions ended. “Peo­ple are aware that em­ploy­ers are in no mood to re­hire,” he said. That pro­vides still more in­cen­tives for sav­ings.

“If Amer­i­can house­holds be­come more fru­gal, it wouldn’t be bad for the long term, but it could be prob­lem­atic in the short run,” said William Gale, di­rec­tor of eco­nomic stud­ies at the Brook­ings In­sti­tu­tion.

The ris­ing sav­ing rate will be a con­straint on eco­nomic growth, said Mr. Bau­mohl, who es­ti­mates the econ­omy will ex­pand be­tween 2 per­cent and 2.5 per­cent for the first two years of the re­cov­ery. That’s sub­stan­tially slower than the re­cov­er­ies fol­low­ing the deep re­ces­sions of 1973-75 and 1981-82. Dur­ing the first two years of those ear­lier re­cov­er­ies, the econ­omy grew at an­nual rates of 4.6 per­cent and 6.5 per­cent, re­spec­tively.

Some economists em­pha­size the “para­dox of thrift,” a con­cept first de­vel­oped dur­ing the Great De­pres­sion by John May­nard Keynes. If ev­ery­body con­sumes less to save more, then no­body will be bet­ter off be­cause fall­ing con­sump­tion will lead to de­clin­ing out­put, which will lead to de­creas­ing wages and ris­ing un­em­ploy­ment. In the end, sav­ings will not have in­creased — thus the para­dox.

Over the long run, how­ever, economists agree that a ris­ing Amer­i­can sav­ings rate pro­duces huge ben­e­fits.

More sav­ings could be chan­neled into greater busi­ness in­vest­ment, which raises pro­duc­tiv­ity, the ba­sic build­ing block for a ris­ing stan­dard of liv­ing. Home-grown sav­ings could also be used to fi­nance the bud­get deficit of the fed­eral gov­ern­ment, which would no longer have to rely as much on Chi­nese and other for­eign in­vestors, whose long-term in­ter­ests may not be the same as those of more fru­gal Amer­i­cans.


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