American consumers: Off their trolleys
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From The Economist print edition
Consumer spending may have hit bottom, but America’s mountain of debt means the climb back up will be slow and painful
CONFLICTING news this week from California, one of the centres of the housing bust. Just north of Los Angeles, a Texas bank was tearing down a half-built development of luxury houses that had fallen into its hands. With the market for flashy homes dead, the bank reckoned it made more financial sense to destroy them than to complete them.
Farther south, Jeffrey Mezger, boss of KB Home, a well-known LA-based home builder, was calling a bottom to his segment of the housing market. But KB Home’s secret, he said, was to sell custom-built homes that were smaller and cheaper than before, and priced to compete with a flood of cut-rate foreclosure properties. “Homes must change with the times,” he believes.
Whether it is for affordable homes or cheap goods, Americans are peering through the wreckage of the credit crunch and starting to buy again. After falling sharply in the second half of last year, consumer spending rose in the first quarter, and even sales of homes and cars have edged up from deeply depressed levels. Anticipating a rebound, shares of retail companies have soared.
Ben Bernanke, the Federal Reserve chairman, on May 5th characterised the news on consumers as “somewhat better”. That cautious endorsement qualifies as downright ebullient compared with the pervasive gloom of a few months ago. A Fed survey of bankers, released on May 4th, gave a further hint of good news for consumers: though banks are still tightening standards on consumer loans, fewer of them are doing so than three months before. Meanwhile, there has been a long-overdue flurry of activity in the Fed’s programme for restarting the securitisation market. On May 5th it supported the issuance of $10.6 billion of securities backed by student, car, credit-card, small-business and equipment loans.
But do not mistake the bottom for a vigorous rebound. Consumption may be growing again, but there is every chance it will remain depressed in coming years because of weak income growth, depleted wealth and tightened credit.
Since the early 1980s, spending by households on goods, services and homes has grown faster than GDP, making it the locomotive of American—and global—expansion. By 2006 it accounted for 76% of nominal GDP, the highest since quarterly data begin in 1947 (see top chart).
This was accompanied by a steady decline in the personal saving rate and a rise in household debt relative to income. By itself, this was not a problem; household debt has risen relative to income since the 1950s, as a growing share of the population has taken out mortgages. Despite the higher debt burden, falling interest rates kept total household financial obligations—interest payments, rent and leases—within a range during the 1980s and 1990s.
An inflection-point occurred around 2000. Income growth stagnated but debts continued to grow rapidly, from 94% of income to 133% in 2007. The share of income devoted to servicing those obligations also jumped. A study in 2007 by Karen Dynan and Donald Kohn, both of the Fed, attributed that partly to more of the population reaching home-buying age, and mostly to a rise in home prices which made it possible to borrow more.
Financial innovation also played a role as the industry devised new ways for Americans to borrow against their homes. One manifestation was the plethora of credit-card offers to even marginal borrowers: more than 8 billion poured into Americans’ mailboxes in 2006, according to Mintel Comperemedia, a consumer-research firm. From 2003 to the end of 2006, consumers borrowed almost $2 trillion against their properties via home-equity loans and “cash-out” mortgage refinancings. A dramatic reversal is now under way. Last year household wealth fell by 18%, or by $11 trillion. Macroeconomic Advisers, a forecasting firm, estimates the resulting negative “wealth effect” will depress consumption by 2% this year.
The financial crisis has killed off many of the loan products that had expanded access to credit during the boom. Subprime mortgages have disappeared and refinancings that deliver cash to homeowners are subject to stricter underwriting standards and higher fees. In the first quarter the credit-card industry sent out only a quarter as many solicitations as it did a year earlier (see bottom chart, above).
A more enduring restraint will be the pressure on consumers to reduce their debts to more manageable levels relative both to income and to the much lower value of their homes. This effect is difficult to quantify, since so many factors determine consumers’ preferred saving rates and levels of debt: assets, retirement goals, expected income, risk tolerance, access to credit, age, and so on. Some bearish analysts argue that debt ratios and saving rates ought to return to their levels of the early 1950s, but others reckon it would be enough to go back to 2000 for households to feel comfortable with their debts again.
This process, known as deleveraging, requires consumption to grow more slowly than income in coming years. A sudden rush to return debt ratios to where they were in 2000 would require ridding households of some $3 trillion in mortgage debt—an almost impossible task. More probably, mortgage debt will grow more slowly than income through a combination of lenders writing off impaired loans, homeowners paying down existing mortgages and new homeowners taking out smaller mortgages than in the past. Bruce Kasman of JPMorgan Chase estimates that the most dramatic phase of increased saving has already occurred, and spending will grow only a bit less than income.
But Martin Barnes of BCA Research, a financial-forecasting service, is more pessimistic. For debt to return to a more sustainable trend, real consumer spending would need to grow by just 1.3% a year from 2009 to 2013, the weakest such five-year stretch since the 1930s. It could grow even more slowly than that if taxes rise faster, he reckons, or if stagnant productivity impedes real-income growth.
This implies that for America to grow at a trend rate of about 2.5% something else will have to grow more quickly. Ideally that would be exports and investment. But given the torpor in the rest of the world, that will not be easy.