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Outlook on Normal Now

The Great Recession officially ended more than two years ago, yet its aftershocks still linger. With sour economic updates about unemployment, the housing market, the stock market, and the nation’s debt crisis constantly in the news, consumers haven’t leapt vigorously back into spending mode. They are feeling frugal—out of fear or out of necessity—and it’s not a stance they're going to shift any time soon.

The turbulent economy of late has altered the way people of all ages and income levels approach their personal finances. From cutting back on discretionary purchases, like vacations, to paying off debt and saving more, consumers are still tending to their financial wounds.

“People are scared to spend with all the uncertainty and the economic outlook,” says Werner De Bondt, finance professor and director of the Richard H. Driehaus Center for Behavioral Finance at DePaul University in Chicago. “Everybody is in defensive mode. With respect to the past they feel anger, with respect to the future they feel anxiety, and with respect to Washington they feel resignation.”

That anger comes from numerous hurts, including the financial meltdown of the late 2000s and its subsequent stock market plunge, as well as the housing market bust in which millions of homeowners lost their largest asset. People are resigned to an uncertain future as state and federal lawmakers seem more interested in advancing their political positions than in solving America’s financial problems. Many are anxiously looking for evidence of a second recession as they weather the uneven recovery in the job and housing markets.

It doesn’t help that the recovery has favored a narrow slice of consumers, and wealth continues to concentrate in the highest echelons of society. In the past 30 years a gigantic share of economic growth fell to the top one-hundredth of 1 percent, who in 2008 made an average of $27 million per household. The average income for the bottom 90 percent was $31,244, says Emmanuel Saez, the E. Morris Cox professor of economics at University of California-Berkeley and director of the Center for Equitable Growth, whose research traces decades of income disparity.

In the past—such as the roaring 20s before the Great Depression or the 1980s—such yawning gaps in wealth equality culminated in major economic crises. And that’s where the United States economy is right now.

In fact, it’s worse, according to Saez. In 1928, right before the Depression, 0.01 percent of the population enjoyed 892 times more income than 90 percent of the population. Today, the top 0.01 percent has 976 times more income than 90 percent of the population.

Until there is a more even distribution of assets, the economy will probably stay troubled, says Robert Reich, former U.S. Secretary of Labor, in “The Limping Middle Class,” an article published in The New York Times on September 3, 2011. However, he also notes that strengthening the middle class has been one of the keys to Germany’s economic health, so there is a living model in which consumers with disposable income benefit the economy as well as the entire spectrum of earners.

Home for Sale

Housing and jobs

Still, for the average citizen, the trouble continues unabated. Both the job and housing markets have not recovered completely from their upheavals. On August 11, 2011, National Public Radio reported that more than 800,000 to 900,000 people expected to lose their homes to foreclosure this year on top of the 1 million who lost their houses in 2010. In addition, more than one out of five homeowners are currently under water on their mortgages, meaning their home value dropped so far they owe more on their mortgage than the house is worth. Gone are the days of feeling prosperous as values climbed steadily every year and consumers could cash out that equity for additional spending.

These upside-down mortgages spawned a trend toward cash-in refinancing, in which the homeowner must put money into a transaction to have enough equity to refinance. Today, cash-in refinancing is more common than cash-out refinancing, says Pat Tschosik, consumer strategist for Ned Davis Research, Inc., based in Venice, Florida. In the mid-2000s, between 80 and 90 percent of refinancings were cash-out; last year cash-ins hit a peak of nearly 45 percent compared to 23 percent cash-out refinancings.

So even though mortgage rates are at historic lows, consumers watch in frustration, because they can’t afford to put thousands of dollars into their homes in order to secure these rock-bottom rates. A refinancing surge certainly won’t be coming from the unemployed or workers whose hours have been cut.

Even with all of the lingering bad news, consumers have been spending more lately, says Toby Madden, regional economist for the Federal Reserve Bank of Minneapolis. Consumer credit rose 7.7 percent in June, and people are spending and borrowing more this year than in 2009 and 2010. However, spending levels are pretty uneven, segmented by the type of consumer. “If they’re well-to-do consumers, they are still spending but not doing as much conspicuous consumption. If they’re consumers from the lower end, they are still spending, but they are just getting by,” Madden says.

That spending disparity has a lot to do with the types of jobs being created post-recession. Employment in professional and business services as well as education and health services grew substantially more than jobs in retail and manufacturing. In addition, the unemployment rate for people with college degrees in July was 4.3 percent compared to workers with some college education at 8.3 percent and 9.3 percent for those with a high school diploma, says Tschosik.

“There is a large group of people who never really came out of the recession, and they are still hurting,” Tschosik says. “The high end has bounced back much better from the economy than the low end has. ...that means the frugal consumer is here to stay for the next five years.”

All of this economic uncertainty is trickling down to people’s financial decision making at all income levels. “Our clients are far more concerned about not losing their money and producing some income than the mentality that they are willing to take risks to make their money grow,” notes Bruce Bushman, a principal in Spokane, Washington, for LarsonAllen Financial, LLC.

There was hope in 2009–10 after the economy showed some signs of improving, but the low and slow recovery ultimately left deep bruises on consumers’ psyches. A 2010 survey from the Pew Research Center found that 55 percent of adults in the U.S. labor force experienced a work-related hardship, whether it was unemployment, a pay cut, reduced hours, or a move to part-time work. So the consumers’ cloudy outlook is warranted.

In addition, the Great Recession led Americans to downsize their expectations about retirement and their children’s future. They’re beginning to lose hope in the American Dream and the country’s belief that one’s children usually improves on the success of their parents. That seems to be slipping away for the middle class earners, whose incomes have barely improved since the 1970s. Between 2000 and 2010, middle class income even dropped 7 percent, according to the U.S. Census.

And with the tough job market, many young people can’t afford to live independently. According to U.S. Census data reported in an article published in the Chicago Tribune on September 21, 2011, 14.2 percent of people ages 25–34 are living with their parents, compared to 11.8 percent before the recession began in 2007, It’s hard to say you’re living the American Dream when your life is unfolding under your parents’ roof. A recent poll from Xavier University’s Center for the Study of the American Dream confirmed that struggle: 69 percent of respondents believe it is harder to reach the American Dream these days compared to past generations.

Americans truly have become more frugal in their spending and borrowing habits, concerned that it could take many years for their house values and family finances to improve. De Bondt mentions the burdens of tax increases, boosts in health care premiums, and government cuts. “People are in a state of paralysis, and they don’t know what to do anymore.”

Behavior changes

Even feeling paralyzed, consumers did make real shifts in their savings habits to survive a setback or in hopes of improving their financial pictures. They have consistently squirreled away more money since the recession hit in 2007, going from a zero or even negative savings rate to more than 5 percent in the past three years.

It’s human instinct to create a solid financial cushion when times are bad and to be more free with money during boom times, says John Gustavson, a principal and senior financial advisor in Minneapolis for LarsonAllen Financial, LLC. To that end, consumers generally coupled their boosted savings rate with a concerted effort to pay off debt. This deleveraging has actually been underway simultaneously for consumers, businesses, and government, and it’s a process that is going to continue for a number of years, he adds.

The results have been uneven so far. Armed with generally cleaned up corporate balance sheets thanks to low interest rates, businesses look strong overall. However, government debt is worse due to increased spending aimed at stimulating the economy. For individuals, debt loads are better than they were two years ago, though they still have red ink to pay off. They also need to rebuild their savings cushions. “People are starting to save more,” says Gustavson, “which is positive for our country going forward.”

Though people spent more freely in 2010 and 2011, they want to know they are getting a deal, observes Bushman. Many clients also get in touch to ask whether they can afford big-ticket items. “Before they used to see something and go buy it and not worry about it,” he says. “Now there is a more thoughtful process: Is this something I really need? Is it something I can afford? They are consulting with us, their asset managers, to see whether the item fits in their budget.”

Of course, having an asset manager is a luxury average families can’t afford. But even without a financial consultation, most consumers are spending cautiously and putting plans for big purchases on hold.

Consumer-driven economy

This reluctance to spend, regardless of reason, continues to affect our economy. Consumer spending made up 70 percent of the country’s gross domestic product, or $10.2 trillion, in 2010. When spending decreases, even 1 or 2 percent, it is invariably associated with falling gross domestic product (GDP) and serves as a main indicator of a recession, says Lee McPheters, research professor in economics and director of the JPMorgan Chase Economic Outlook Center at the W.P. Carey School of Business at Arizona State University in Tempe.
They are aiming to restore their balance sheets and turn right-side-up on their mortgages, a process that could take a decade.

It didn’t look good in the second quarter this year, when consumer spending barely grew at all; it was up only 0.1 percent on an annualized rate. McPheters sees this lull in economic activity continuing for some time as consumers pay off debt. They are aiming to restore their balance sheets and turn right-side-up on their mortgages, a process that could take a decade.

“There were more than eight million jobs lost in the recession, and it will take several years to get back to full employment,” McPheters adds. “This is not so much a ‘new normal’ as a protracted period of slow economic growth. Consumers who have steady jobs and do not have a house underwater are still affected by weak consumer confidence due to uncertainty about the speed of the economic recovery.”

The general nervousness and caution abated a bit this summer, when consumer spending increased 0.8 percent in July, beating economists’ expectations of 0.5 percent. Jobs news was mixed, with more companies advertising positions and fewer businesses laying off. But the unemployment rate stayed lodged at 9.1 percent this fall.

By now, reduced spending is an ingrained habit for many consumers. Fifty-seven percent of Americans reported that they generally were spending less money than they used to compared to 50 percent in July 2010, according to a Gallup poll. This reduced spending will be their new spending level, report 38 percent of respondents. Consumers’ assertions were backed by their actions: they continue purchasing at a level consistent with 2009—much lower than their pre-recession spending.

Economy Car

In addition to purchasing less, people are making different spending choices when they do buy. Auto sales have improved in recent years, but Tschosik points out that most of the growth has come from midsize and compact cars. Compact sales are up 16.7 percent year over year, while mid-size vehicles increased 11.9 percent. This compares to full-size and luxury cars, which increased 7.3 percent and 1.1 percent respectively.

Those who take vacations are more often staying closer to home, and they are shopping consistently at discount stores like Target and Walmart. However, the restaurant industry has shown signs of life recently. The National Restaurant Association’s Restaurant Performance Index shot over 100 for six of the past seven months ending in June. With stronger same store sales and customer traffic, restaurant owners are generally optimistic, and 40 percent are projecting higher sales during the rest of 2011.

Consumers are finding ways to treat themselves with a few more meals out or smaller discretionary purchases like home decor or clothes as their confidence in the economy grows. Many just gave in to their pent-up desires to spend, even if it was at a fast-casual restaurant or for cheap chic items.

Frugal future?

Though economic signs are pointing to several more years of tamped down spending and more savings, there are other factors at play: demographics. The troubled economy threw a wrench into the retirement plans of countless Baby Boomers, whose investment portfolios and home values dropped significantly.

This stall in Boomers’ retirement is preventing the Gen X cohort from moving up into leadership positions and kept many members of the Millennial generation out of the workforce, notes Tschosik, whose firm recently published a report called Demographic Destiny: U.S. Demographic Shifts and Implications for Consumer Durables and Services.

That slow economic growth will continue until roughly 2015, when greater numbers of Boomers retire, the report projects. Ultimately this will pave the way for more Millennials to enter the workforce in a meaningful way. And once they are employed they can create households in greater numbers—households that buy homes, fill them with new furniture, purchase second cars, and have children. This will be an important part of getting the economy moving again.

Most concerning is that the largest demographic group in the country, Boomers, is trending toward less spending and will eventually be a bigger drag on the country’s economy as they tap into entitlements like Medicare and Social Security. “What we’re seeing is that the top three best population growth rates are from the three lowest-income groups,” says Tschosik. “People who have lower or declining incomes are growing faster than those who have accelerating income. There are more people with less income. I really think it’s bad.”

It also doesn’t help the economy that Boomers are in their peak saving years as they get closer to retirement. This inclination to save instead of spend has been exacerbated by the volatility in the stock market and the losses in their portfolios, says Bushman.

“There is going to be less affluence. Boomers are leaving a big hole in the economy and you will have more frugality,” Tschosik says. “Gen X is too small to fill the shoes of Baby Boomers. Those companies in retail with a strong value proposition will do well, and those on the high end will be hurting.”

It may be true that boom times aren’t coming any time soon, but there is still hope. Technological advancements could give the economy a surprising kickstart. “And you don’t want to underestimate the U.S. consumer, who does have a propensity to spend when people think they won’t,” Gustavson says. “When they get some extra discretionary income, it does seem like it finds its way to retailers and vacations and such.”

It might be a few more years down the road before people make the transition from frugal to flush, but don’t count out the U.S. consumers’ eagerness to help our economy bounce back.

 

Suzy FrischSuzy Frisch is a freelance writer whose work has appeared in publications across the country.
Contact Suzy at suzyfrisch@yahoo.com.

 


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