"No interest until 2014," read the massive red sign outside Big’s Furniture in Henderson, Nev. It beckoned Diane Lewis to the store’s year-end liquidation sale. “I had to pull in,” she said as her sons frolicked on mattresses nearby. “We really need to get us a new bedroom set; their old one is kinda beat up. If we can get that financing deal, we can make it work.” As with most in this hard-hit region, the economy hasn’t been good to Lewis, whose husband just got a new job after being laid off for eight months.
They’re two months behind on their mortgage, “but we’re gonna catch up,” and she figures the family probably owes about $20,000 on various credit cards. “I know I probably ought to wait a little longer,” said Lewis, a hairdresser, “but this is a pretty good sale, so I think we might buy something if they’ll approve us. I mean, 2014 is a long way off, you know?”
Old habits die hard. It was only last year that shell-shocked consumers were pledging their allegiance to the “New Frugality.” Chastened by the brutal lessons of the worst economic downturn in decades, Americans swore off conspicuous consumption and resolved to embrace the thrifty ways of their grandparents who lived through the Great Depression. But as any dieter can tell you, resolutions are made to be broken.
Even as Americans are still struggling to meet mortgage payments, pay off credit cards, and replenish savings, they’re also starting to spend again—whether they have the money or not. Last week, fresh numbers showed household spending rising for the fifth month in a row and consumer confidence reaching its highest level since June. Per capita retail sales are now back up to where they were in the fall of 2008, just before the collapse of Lehman Bros. tore the bottom out of the economy. If you factor out spending on cars, which is still 18 percent below its 2005 peak, Americans’ total spending on goods and services has now passed pre-crisis highs.
“People are going through frugality fatigue,” says Marshal Cohen, chief analyst at NPD Group, a market-research company. That’s one reason retailers expect this holiday-shopping season to be the busiest since at least 2007, with a gain of 2.3 percent over last year’s sales. Retailers are betting on pent-up demand for electronic gadgets, clothes, and luxury goods, not just the tightfisted bargain hunting that drove sales all during the downturn, says Cohen. Only 56 percent are offering heavy markdowns on their products, versus 96 percent a year ago.
It would be premature to herald the triumphant return of the American consumer as the engine of renewed economic growth, which is what happened during the recoveries following the 1990 and 2001 recessions. There’s still too much economic uncertainty—between unemployment that’s nearly 10 percent, the rising cost of basics like medical bills and child care, and the renewed slide in home prices that began in recent weeks.
But neither are we witnessing the renaissance of the frugal American. Even though 89 percent of Americans tell Gallup they’re watching their expenditures very closely, spending is heading back up anyway. “The story everybody wants to tell is that we’ve learned our lesson and will be thriftier going forward,” says Karen Dynan, a household-finance economist at the Brookings Institution. “But I don’t feel we have.”
Yes, American households have pared their debt—from $12.5 trillion in 2008 to $11.6 trillion at the end of September, a drop of 7.6 percent. But the lion’s share of the decline has come as a result of home foreclosures and defaults on credit-card debt—hardly an indicator of improved habits of personal finance. Yes, Americans are now putting away more money: 5.7 percent of disposable income, compared with just 0.8 percent in 2005. But that’s already back down from 7.6 percent in early 2009, and still far below the 10 percent or more that Europeans and Asians save. Relative to income, debt is still near record levels, and twice as high per family as it was in the 1980s. If, as we’ve all been told, the nation’s long-term economic health depends on boosting savings and paring debt—both at the personal and government level—then we haven’t made very much headway. But how do we get back on course, or even agree on one? President Obama’s fiscal commission set off a firestorm with its recent draft report proposing to eliminate the federal deficit by cutting entitlements and subsides while raising taxes. You can expect the controversy to flare up again when the final report is due out this week.
The truth is that spending may be hard to contain. Entire generations of consumers have grown up with the idea of instant gratification and the credit culture that comes with it. Ever since Henry Ford popularized the installment loan to sell his newly mass-produced cars, the idea of saving to buy something has nearly disappeared from the American financial vocabulary. “People change very slowly or not at all,” says Claudiu Dimofte, a consumer-behavior professor at Georgetown University. “More often than not you just revert to your routine as soon as you get the chance.” That’s been the case for Harry Dugan, a respiratory therapist in Allamuchy, N.J. Dugan, 50, is underwater on his mortgage and has tried for two years now to be thrifty. But he’s had a bit of a relapse, buying a $900 50-inch plasma TV and a $21,000 Toyota Prius. “It was an impulse buy,” he says. “If I could go back, I’d get something cheaper.”
The New Austerity is easier to talk about than it is to practice—and not just because Americans are hard-wired to buy stuff. For middle-class people already leveraged to the hilt and facing rising costs, where would they cut back? The mortgage is still due every month, as are the car payment, the doctor’s bill, and the college tuition. Some of the biggest rises in consumer spending in 2010 have been on health care and education, hardly costs that can be slashed. And with all that money going out the door, how can a family even begin to squirrel away some cash? Five years ago, Crystal DiLuzio, 43, and her husband, Carmen, 50, had about $50,000 in their savings account, and they were easily able to meet the $1,300-a-month mortgage on their three-bedroom home in Wilmington, Dela. But things have gone downhill since then. Carmen lost his job and decided to get his trucking license, which cost $5,000, but the work he’s landed since has paid considerably less than his old job. Crystal took a full-time job at an elementary school but then lost it last year, cutting the family’s $50,000 income in half. Since the start of the recession, the DiLuzios have racked up more than $15,000 in debt—much of it from her husband’s schooling and medical bills to treat their 9-year-old daughter’s immune deficiency. They’re looking at refinancing their mortgage in order to afford the monthly payments. “I don’t put anything in savings anymore,” says Crystal. “I don’t even look at my bank statement. It’s too stressful.”
If anything, there’s a rising class divide between savers and spenders. Upper-income confidence is rising fast. Luxury sales have jumped far above their crisis lows, if not yet to their pre-recession levels. In October, BMW’s U.S. sales were up 17 percent over the same month in 2009, Porsche’s up 61 percent, and Lexus’s up 8 percent. Saks Fifth Avenue and Neiman Marcus reported sharp gains in October same-store sales of 8.1 and 11.5 percent, respectively, compared with the same month in 2009. Even plastic surgeons are seeing an uptick in nip-tuck. Park Avenue doctor Michael Fiorillo says clients who spent the last couple of years away from his office are now coming back to get work done. “People were really cutting back on the big stuff like face-lifts and nose jobs and doing the less expensive procedures like injectables and laser treatments,” says Fiorillo. “Now I’ve personally noticed it’s coming back. People are job hunting, and they want to look and feel better. I think that after such a long time of cutting back, many people are tired of depriving themselves.”
It isn’t just the rich who are indulging in a spending fix. Impatience with the painfully slow pace of economic recovery has, ironically, also sent some people who can least afford it back to the malls. “I keep waiting for things to get better and they just don’t,” says Maria Diaz, a 30-year-old cocktail waitress at a Las Vegas casino who was evicted from her apartment for not paying her rent in 2009 and is now living with her mother and stepfather. “After a while, I just decided, ‘Screw it. I need some new clothes. I’m going to get them.’ My mama’s not happy, but I don’t care. You stop spending and you stop living.”
Although Americans have saved less, spent more, and racked up more debt than most Europeans or Asians, the urge to splurge isn’t about innate cultural differences or moral turpitude. Habits of spending, saving, and credit are all about incentives, says Carmen Reinhart, a University of Maryland specialist on debt and financial crises. “When easy credit is given, it is usually taken,” she says. Many of the practices that got Americans into trouble either don’t exist or are expressly outlawed in most other countries, she says, including the home-equity loan, the zero-down mortgage, and the little-documented subprime mortgages that were targeted specifically at the poor. Those countries with similar “financial innovation” in lending, like Britain, also ended up with a U.S.-style credit bubble, along with a buy-now-pay-later consumer culture. In thrifty Germany, on the other hand, banks offer low-income households a “mortgage-savings contract” that combines a savings plan for a down payment with a follow-on mortgage. “People love to make moral judgments, but in countries where there is less access to credit, consumers save more to buy the things that they want,” says Steve Blitz, chief economist at ITG research in New York. Before the viral spread of the home-equity loan, paying off a mortgage on a house—and having it all paid for after 30 years—was another way to save that’s largely disappeared, says Richard Thaler, a behavioral economist at the University of Chicago. Some of these incentives are now beginning to change, following this year’s legislation on Wall Street reform, including tighter lending standards and the establishment of the new Consumer Financial Protection Bureau.
What’s more, America’s tax code has massively promoted consumption and debt while punishing savings and investment, says David Rosenberg, chief economist at Gluskin Sheff. For most governments around the world, the biggest source of revenues is the consumption tax, while America puts a heavier burden on income. The home-mortgage-interest deduction, which most other countries have abandoned without damaging the rate of home ownership, literally rewards Americans for accumulating outsize debt. If some of these incentives aren’t changed, then frugality will last only as long as the memory of the crisis, says Reinhart, whose ironically titled book This Time Is Different chronicles 250 credit bubbles and financial crises in economic history. If that history is any guide, she says, the next wave of easy credit will inevitably come—and inevitably lead to trouble.
If you believe that higher savings and a lower debt burden are the basis for a more stable economic future, then the to-do list for Washington should be clear. Subsidies for racking up debt—such as the home-mortgage-interest deduction—need to be phased out, as the president’s bipartisan deficit commission has proposed. (The phaseout would grandfather current mortgages.) Plans bogged down in Congress to create tax-free savings accounts need to be revived. Some taxation should be switched from income to consumption. Stricter underwriting and new bank limits on home-equity lines of credit should be cast into permanent regulation.
What goes for private households counts double for the government. Unless there is a credible game plan for Washington to cut the deficit, says Reinhart, consumers and businesses will remain nervous over future taxes and benefits. Resolving uncertainty over the public debt needn’t mean immediate austerity that would risk plunging the U.S. economy back into recession but rather long-term moves, such as phasing in a higher retirement age and other curbs on entitlement spending. Ultimately—and most controversially—restoring consumer confidence may require fresh write-downs of bad lending. As long as there are still millions of Americans who clearly can’t afford to repay their mortgages, as long as house prices continue to fall, and as long as all these bad loans remain on lenders’ books, there will continue to be dead weight dragging down homeowners, the financial sector, and the economy at large. In past financial crises, it has been those countries that moved the fastest to clean up bad loans in their banks (like Sweden in the 1990s) that saw the quickest return to growth and consumer spending. Those that let zombie banks fester (most notoriously Japan) saw years, if not decades, of stagnation.
Until some of these things start to happen, there’s limited comfort in knowing that consumers like Hope Good are helping to revive the retail sector. Before the recession, Good, who lives in Palm Beach, Fla., “had no problems buying 12 pairs of shoes at one time,” dropping $400 a week on shopping and entertainment on a $33,000-a-year accountant’s salary. In June 2009 she was laid off and had to take a lower-paying job, and so she started staying away from the mall and trying to reduce her $7,000-credit-card debt. But in August of this year, she got hired at a real-estate law firm, and her salary nearly doubled to $40,000. She has since gone on two vacations, to North Carolina and California, and is planning one to London for next year. She says she spends up to $300 a week on entertainment now. The shoe shopping is back, too. “I had been so frugal last year,” she says. Did that year of frugality make her feel she needs to sock something away for a rainy day? “I am sure that if I wanted to save I could, but I feel like I am making more money, so let’s have some fun,” she says. Yes, spending is great fun, until the bill arrives. That’s a lesson we’ve learned the hard way. Or maybe we haven’t.
With William Underhill, R. M. Schneiderman, Joel Schectman, Steve Friess, Tara Weingarten, and Daniel Stone