The most revolutionary notion in commerce today is one of the oldest. If you want to buy something, you may actually have to pay for it. We are quickly reverting from a borrow-and-buy model to the old school cash-and-carry model our grandparents and great grandparents knew. It may seem passing strange now, but paying hard currency for goods and services has been part of our consuming DNA pretty much from the beginning of time. Sure, medieval alehouses and mead halls may have allowed customers to run up a tab, and the Olesons extended store credit to Ma and Pa Ingalls in "Little House on the Prairie." But widespread consumer credit is really a 20th-century phenomenon. It got started in the 1920s, when expensive consumer durables like cars and refrigerators were first produced in mass quantities. It wasn't until Bank of America began carpet-bombing California with credit-card applications in the 1960s that the debt wave started in earnest.
In the decades since, consumer credit became so pervasive that paying cash became passé. Want a new $32,530 Dodge Ram Crew pickup? Take a lease. Sick of your old house? Get a 100 percent mortgage and trade up. Face-lift? Round-the-world cruise? New PC? A $300 sushi dinner? Whip out that plastic. It was this behavior—the endless willingness of lenders to lend and borrowers to borrow—that kept the consumer economy humming uninterrupted from the early 1990s, straight through the brief recession of 2001, until the credit meltdown of 2007.
But many of those who extended credit recklessly are now acting like a single twentysomething who, after having a few bad affairs, takes a vow of celibacy. Students are returning to campus this fall to find that lenders have graduated. Retailers who freely extended credit to any customer with a pulse are deploying bean counters armed with sophisticated software to sniff out potential liabilities. When higher rates and fees don't deter their borrowers, credit-card companies resort to slashing credit lines. "We predicted there would be some degree of spillover from mortgage meltdown," says Curtis Arnold, founder of CardRatings.com. "But the credit line reductions by big credit-card companies in the last six months has been fairly unprecedented."
This shock to the system has the capacity to alter the already fragile psychology of the consumer, on whom the fortunes of multitudes ride, from stockholders in Saks to factory workers in China. And make no mistake, deducting the price of a pair of shoes directly from your bank account packs a much more potent emotional punch than charging the pair of Allen- Edmonds loafers on your American Express platinum card. Chalk it up to a concept called "the pain of paying," says Dan Ariely, the author of Predictably Irrational. Imagine that a restaurant, rather than charge $30 per meal, charges 50 cents per bite, with a waiter standing tableside collecting after each chomp. That would be an extremely unpleasant meal. But credit puts a safe distance between the ecstasy of consumption and the agony of payment. "If it's more difficult to get credit, it might make people feel more pain of paying and therefore spend less," says Ariely.
The availability of credit also changes the calculus people make about what they can afford. Blowing $6,000 on a week in Tuscany might be tough to swing if you have to pay for it all next month. Convince yourself it's a once-in-a-lifetime experience that you can pay for over three years, and it becomes a bargain. With credit, Saturday night means dinner and a movie. When you pay cash and have a fixed budget, it's dinner or a movie.
The tightening of credit is forcing more people to confront these uncomfortable choices. In the second quarter, credit giant Mastercard reported that the gross dollar volume (GDV) of credit charges processed in the U.S. rose just 0.7 percent from 2007, while the GDV of debit charges rose 15.8 percent. The retailer Target said that in the second quarter, for the first time in memory, the percentage of sales charged to credit cards fell, while the proportion of purchases made with debit cards rose. That's partially by design, since the company has undertaken an "aggressive reduction of credit lines and significant tightening of all aspects of our underwriting." (Translation: No Credit for You!!) Target's same-store sales fell 0.4 percent in the second quarter.
Leverage is an appropriate synonym for credit because it allows you to lift more than you could with simply your own financial muscle. Take away the leverage, and the power spender becomes a 98-pound weakling. That's clearly a factor in the housing market. In 2007, according to the National Association of Realtors, 45 percent of first-time home buyers put no money down, and the median first-time homebuyer financed a massive 98 percent of the purchase. But no-money-down mortgages began fading in late 2007 and largely disappeared in the cruel winter of 2008. No wonder existing home sales fell 13.2 percent in July from last year, while new home sales plummeted 35.3 percent.
In effect, the lack of credit makes things seem more expensive to consumers, even if prices are holding steady. And in a world of scarce credit, consumption is likely to resemble a meal at Dan Ariely's nightmare restaurant: a series of small bites rather than an all-you-can-eat extravaganza.