Earn What You Spend

Nouriel Roubini joins the ranks of those concerned about the drop in consumer spending [via Clusterstock].  It has certainly occupied my mind of late (see here and here most recently).  Roubini gives us twenty reasons why we are seeing the American consumer drastically pull back in their spending.  The first reason of course catches my eye as the most relevant, given that I am so focused on the ratio between what we earn and what we spend: the consumer has spent the last few years living well beyond his or her means. 

Before we elaborate on the twenty points, it’s important to go back to the basics.  Roubini notes “at this rate of free fall in consumption real GDP growth could be a whopping 5% negative or even worse in Q4 of 2008.”  That’s astounding.  The points to keep in mind: 

• The crisis began in the housing sector.  Consumers were overleveraged on their houses, and loan sharks pushed an increasing number of loans that had little hope of being paid back.
• An entire industry was built on an incredibly shaky foundation.  Entire firms had placed huge side bets on the subprime mortgages - CDOs - that would mimic the movement of these underlying mortgages, but with no mortgage underneath it.  That is, they took these subprime mortgages and drastically increased their stakes with massive leverage. 
• As housing prices fell, the credit markets froze, and the whole deck of cards began to unravel. 
• Now the crisis comes full circle, back to the consumer.  Consumer spending makes up 70% of our GDP.  

Rather than listing the full twenty reasons, here are a few that are worth highlighting:

• Consumers have lived beyond their means.
• Our savings rate is approaching zero, yet we have large amounts of debt to service.  This has to come from somewhere, so we’re going to be forced to begin saving again. 
• We are facing the ‘wealth effect’ because of falling housing and equity prices - we feel less wealthy, so we spend less. 
• Consumer credit is tightening.
• Consumer confidence is at record lows.
• Unemployment is rising.
• And, the most profound point for last: “to bring back the household savings rate to the level of a decade ago (about 6% of GDP) consumption will have to fall – relative to current GDP levels – by almost a trillion dollars.   If all of this adjustment were to occur in 12 months GDP would contract directly by 7% and indirectly (including the further collapse of residential and corporate capex spending in a severe recession) by 10% …” and, even if it adjusts to this level over the next four years, we’re still facing “the worst US recession since WWII.”

This is certainly a frightening list.  Further to this point, the New York Times this weekend detailed how the downturn in the economy inevitably will drag more consumers into bankruptcy.  It’s worth reading the entire article.  Why this downturn is particularly difficult for many to deal with: 

“Earlier downturns followed strong booms, so families went into recessions with higher incomes and lower debt loads,” said Elizabeth Warren, a professor at Harvard Law School and, along with Professor Lawless, part of the Bankruptcy Project team. “But the fundamentals are off for families even before we hit the recession this time, so bankruptcy filings are likely to rise faster.”

We hear a lot about the rising debts of consumers, and here is a graphical look at what this means: 

Source: NYTimes

We’re overburdened with debt at the worst possible time.  Indeed, it seems like we are facing a perfect economic  storm -  by nearly every measure, the prognosis for our economy is not good. The most optimistic are saying we will at best get away with a ‘moderate’ recession that should end in the latter half of 2009.  The pessimistic are quick to throw around comparisons to the Great Depression. Those who believe the comparisons to the Great Depressions are vastly overblown are quick to point to the social safety net our government has erected.  But even that is a shadow of what it once was: 

Government programs in place … to cushion and counter recessions have been scaled back sharply, raising questions about whether they are up to the task as the economic outlook darkens today…

“Unemployment insurance has been weak for a long time, but right now it seems to be quite anemic relative to the need,” he said. “The social safety net in general has not been kept up to date with the changing nature of the work force and the increased economic risks that working families are facing.”

If this seems like an excessive degree of doom and gloom for a Monday, I agree.  I keep looking for the silver lining, the sign that things just may not get that bad.  But the conversations I have everyday - the real world examples of these theoretical musings - are all reflective of a profound nervousness of what lies around the next corner in our economy.  To quote Steve Eisman from Michael Lewis’s excellent synopsis of the current state of Wall Street, “I don’t want the country to go into a depression. I just want it to fucking deleverage.”  Let’s just hope we can have the latter without the former.