Recession tales: Saving vs. spending a tough battle

There's no doubt that the current downturn has changed people's spending habits.

Since the peak in housing wealth, homeowners lost more than $5 trillion in equity and 15 million homeowners own homes that are now underwater (worth less than they owe). Unemployment is hovering near 10% with no clear signs of falling.

Homeowners' previous piggy bank -- home equity -- is no longer available for spending. Even if people still hold a job, many are worried that their jobs are at risk and won't spend except for necessities.

People, afraid for their future also changed their savings habits. In the first quarter of 2008, before the recession took hold people saved about 1% of disposable income. By the second quarter of 2009 the savings rate soared to 5% of disposable income. But now that we appear to be near the end of the recession the savings rate dropped back to slightly above 3% in the third quarter of 2009, as people see the end of the recession in sight.

While economists now don't believe this recession will be as deep as the Great Depression, its depth and length will certainly change people's spending and savings habits for a long time to come.In a recent survey by MetLife, two-thirds of the respondents have reduced spending on non-essential purchases and 57% say they intend to build an emergency fund. A much smaller number of those surveyed actually saved more (17%), consulted a financial adviser (15%) and diversified their portfolio (15%).As you can see from the survey results people have become aware of the need for savings, but how many of them will only make this a goal for a short time until they feel more comfortable about their job situation or their house value starts to climb back up?

Paul Flatters and Michael Willmott looked at just that question in "Understanding the Post Recession Consumer" for Harvard Business Review.

Basically they conclude that four key trends are being accelerated by this recession:
  1. Consumers demand more simplicity. For example they won't spend on expensive home improvement projects if something simpler will fill their needs.
  2. Consumers want ethical business governance. They are mad about the excessive compensation structures at the executive levels when seeing no increase in their own incomes.
  3. Consumers are looking for ways to economize in their daily lives.
  4. Consumers are tending to flit from one offering to another. Consumer loyalty is definitely being tested as consumers look for the cheapest deal.

Four other trends are slowing:
  1. Green consumption. At least temporarily consumers are not spending more on green products, but this is probably not a long term trend. Once the economy improves concern about the environment will likely return.
  2. Decline in respect for authority. Given how badly government regulators missed most of the recent scandals and Wall Street excesses, respect for the government and authority in general has diminished.
  3. Ethical consumption. Right now consumers are looking for the best deal.
  4. Extreme-experience seeking. There's just no money to spend for these experiences. Even less extreme vacations have been cut back. Authors expect extreme-experience seeking to be altered for the long term.
So the big question is whether consumers will truly go back to past spending habits once the unemployment situation improves and house prices start climbing? Or will consumers behave more like those who lived through the Depression and continued to pinch pennies for the rest of their lives?

Personally I think it will be somewhere in between, as long as the early signs that we are moving toward recovery do prove to be true. No doubt many who are near or in retirement will not have the time to rebuild their 401(k)s and will have to alter retirement plans. Those whose portfolios were cut in half will likely be pinching pennies in retirement or continue working for many more years to come.

Younger generations will likely be more careful consumers and better savers than the Baby Boomers, Generation X and Generation Y have been, but I suspect there will be a lot of pent up demand. When clear signs of a recovery is in place, I suspect all generations that can afford it will start spending again, but more carefully -- looking for the cheapest way to do something rather than the most glamorous.

For example, I think the days of gold and platinum tiles used in renovations will be gone. People will look for simpler, cheaper ways to do the things they want.

Many of those who are now getting used to shopping in thrift stores and bartering out of necessity will find they like saving that money and will continue those practices even after the recovery. They will then have more money to save or to use on other things they want. Those who learned this important lesson will be the ones who help to improve our savings rate.

It will be many years before credit is available again for those hit hard by the recession and forced into foreclosure or bankruptcy. While in the past people were able to rebuild credit and start to get credit cards again in three to four years, banks are being much more stingy about who can get credit cards. As losses continue to mount from defaults, everyone without excellent credit scores (over 740) will have difficulty finding credit card deals. Even people with the best scores have seen their available credit cut and their interest rates skyrocket.

Debit card usage is up 20% while credit card usage is down about the same amount. Clearly consumers are shifting to cash. If they don't have cash they're not spending it. But is that permanent or just because they maxed out their available credit and have no choice? We won't know the answer to that until credit is no longer frozen.

I suspect that people are putting off purchases of things they need. Consumers will go back to spending when they feel more comfortable about the state of the economy. I will be very surprised if savings jumps dramatically among the low to middle class families, who are living paycheck to paycheck. Their ability to spend has been cut by inflation year after year as salaries remain flat. The upper middle class and top earners may actually learn from this lesson and save more, but the majority of the population just doesn't earn enough to save significant amounts of cash.

Lita Epstein has written more than 25 books including "The Complete Idiot's Guide to Improving Your Credit Score" and "Working After Retirement for Dummies."
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