If the ultimate cause of the economic crisis was an excess of credit its cure will almost certainly be a contraction of debt. Banks have already tightened their lending standards, mortgage companies are again requiring 20% down on homes loans, and credit card firms have stopped flooding consumers with unsolicited cards. Banks are not lending because they need to support their balance sheets; consumers have limited their use of credit to repair their own household accounts.
It is consumer spending and borrowing that is the occasion for much of the business of lending. Bank balance sheets can be clean and strong, but if consumers decline to borrow or borrow only at much lower overall amounts the condition of the financial system will not matter. If loan demand shrinks then the consumer credit sector will remain moribund and consumer spending will not fuel an economic recovery.
It is not only jobs and unemployment that is restraining spending. If the consumer mindset that sought high leverage as part of an expansive lifestyle is lost then no amount of economic stimulus by Washington will bring it back.
After all what is the stimulus package about except encouraging consumption? And it was precisely that attitude of unsupportable spending across housing and consumer credit that produced this economic mess. Axiomatic maybe, but if no one had bought sub-prime housing Wall Street and Fannie and Freddie could not have created the financial debacle. If consumers' attitudes towards consumption have changed then a world of Washington deficit spending will not recover the economy.
Economic shocks, recessions and depressions have psychological consequences that endure. My parents lived though the Depression and remembered that time of trouble all their lives. Neither of their fathers were ever out of work, neither of their families lost their homes or bank accounts but their notions on spending, the stock market, savings, debt and consumption were formed by the Depression. They never trusted the stock market, their only debt was the mortgage on their house which they saved to pay off early and they shunned almost all kinds of self pleasing spending indulgences.
Will this recession produce such a change in consumer outlook? The answer probably depends on how long it lasts. One of the salient facts of the Depression was its length. For a full decade, from 1930 to 1940, unemployment in the US never dropped below 14%, for much of the time is was considerably higher. The enduring difficulty of that decade burned itself into the psyche of a generation.
Personal checks from Washington do not produce consumption. At best the government can replace some jobs lost from the private sector and create a temporary boost to GDP. Citizens spend freely because they have confidence in the future and in their future income. So many institutions have been damaged or found to be faulty in this crisis that confidence in the US economic system itself has probably been damaged. Government also, the lender of last resort, is operating only as a stopgap. Wary, unconfident consumers are not about to open their wallets and plunge in a new SUV because the Treasury has mailed a $1000 rebate.
How much will the events of the past two years alter consumer attitudes? Are the empty malls and restaurants tied only to current conditions or are they a permanent change? Is the level of American consumer consumption headed down? In the current situation it is difficult to foresee a return to the free spending ways of the past decade but one sure result of this recession is that the longer it lasts the more pronounced will be the change in consumer habits.
Before it is over this recession will have touched almost everyone in the country and the consequent damage to long term GDP growth rates may be far greater and longer lasting than anyone now anticipates.