Say Bye-Bye to Consumer Spending

December 21, 2010 06:55

The spending was driven by easy credit, artificial housing appreciation, and big increases in personal debt. This spending is not coming back. The new frugality is here to stay and it’s catching on.

By Brad Bradley at CJS Forum

Bob and Lisa were a typical American couple raising three children. Bob had a decent job working as an area sales representative and Lisa worked at a preschool while juggling the duties of being a mom and running a household. They owned a home in a nice part of town so their kids could attend a good school. Between a house payment, two car payments, groceries, school loans, gasoline, cable TV, and all the costs of providing their children with a better life, it seemed that every month there just wasn’t enough cash in the bank to pay all the expenses. Bob and Lisa didn’t keep a written budget. Together they were making more than they had ever made in their lives it seemed, and since they had perfect credit, they kept two or three credit cards in case of emergency or unforeseen expenses.

From time to time these unforeseen expenses would come up. First it was the hot water heater, then car repairs and new tires, then Christmas. The kids wanted cell phones, needed new clothes for school every year, and they deserved a good vacation every summer. Bob and Lisa had virtually no savings and, in fact, very soon discovered that the balances on their credit cards had risen, as had the minimum payments they had been making. Lisa paid the bills for the family, and upon a closer look, she realized that they had accumulated over $20,000 in credit card balances over the last three or four years, along with some other debts to retail stores.

She got a call one day from someone offering them a home equity loan that would pay off their credit cards and reduce their monthly payments. Fortunately their home had continued to appreciate in value and they had just enough equity to qualify. However, this loan would cause them to now be maxed out at 100% Loan to Value on their home. Not to worry though since in a few years the house would be worth more and everything would be okay.

This story is all too typical among hundreds of thousands, if not millions of American families over the last ten years. As people are now figuring out, the lifestyle of Bob and Lisa and their methods to support it came to a screeching halt.

In 2006, home equity loans for cash-outs were running at $80 billion per quarter. Today it’s running at one-tenth of that.

Back when credit cards and credit were easy, let’s say an average person used their credit cards for $500 to $600 a month to buy things and cover lifestyle expenses. This person, in essence, was living above their means. By paying the minimum payment on the card, they were able to kick the can down the road. This monthly deficit meant that after one year, they would have $6,000 to $7,000 as an outstanding balance on their credit cards. After three years they owed much more. At this point, they would simply take out a home equity loan and pay them off.

This would free them up to start the process all over again. Because of easy credit and home equity lending, the average American was able to live well above their means every month and never have to face reality.

Now this is over. With the housing crash and credit crisis, these people now find themselves owing more in their combined mortgages than their house is worth. They cannot sell their houses, because they are upside down and don’t have the cash to make up the difference. They are stuck. Their credit card companies have either reduced their credit lines or cancelled their accounts. They can no longer use the credit cards to finance their lifestyle, and they can’t afford their mortgage payments.

Now they must cut their expenses just to survive each month. They have no cash reserves because they never saved and used credit instead, and the credit is gone.

If a family earns about $70,000 per year in total salaries, the take home pay after taxes is about $52,000 per year, or $4,375 per month. They are now figuring out they must reduce their expenses by about 12% in order to make ends meet. This family will make permanent changes in the way they live and how much they spend. They have no choice, because the fuel that drove their spending is now gone. They are literally out of gas.

This is a very typical situation. If there are millions of people like Bob and Lisa, what does that say about the future of consumer spending? You can do the math.

Consumer spending was fueled to new heights over the last decade. Spending rose every year until 2009 when it dropped for the first time since the U.S. Bureau of Labor Statistics began publishing integrated data in 1984. Unfortunately this spending was not driven by higher wages. Household income has not grown in the past decade. According to the Census Bureau’s annual report on income, poverty and health insurance, which was released in September 2009, median household income fell to $50,303 in 2008 from $52,163 in 2007. In 1998, median income was $51,295. All these numbers are adjusted for inflation.

In the four decades that the Census Bureau has been tracking household income, there has never before been a full decade in which median income failed to rise. (The previous record was seven years, ending in 1985.)

With no real increase in wages, but continued increases in consumer spending, the spending was driven by easy credit, artificial housing appreciation, and big increases in personal debt.

This spending is not coming back. The new frugality is here to stay and it’s catching on.

Brad Bradley is the former CEO of Senderra Funding in Charlotte, North Carolina. He now runs a private investment company and is President of CJS and a member of the CJS Board of Directors.

The CJS Forum seeks to promote an open exchange of ideas about the relationship between faith, culture, law and public policy. While all the articles are original and written especially for the CJS Forum, they do not necessarily reflect the views of the Center for a Just Society.

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