Posted by Andrea Rovira in Untagged
The changes will affect almost every aspect of the business of banking
By Dr. Edmond J. Seifried, executive director—Sheshunoff Affiliation Programs, email@example.com
Dr. Seifried is also the chief economist for m.rae resources, inc., a strategic and financial services firm for community banks. He served as Professor of Economics and Business at Lafayette College in Easton, Pa., for over 25 years and serves as the dean of the Virginia and West Virginia Banking Schools. He is also a faculty member of numerous banking schools including: Stonier Graduate School of Banking, and the Graduate School of Retail Bank Management.
Few would dispute that the shape of the economy will be profoundly changed as a result of the fallout from the massive financial meltdown—and with it the longest and deepest recession since the great depression. One thing is certain: the transition will be painful and sometimes perplexing for the business community and consumers. Even fewer, though, are willing to examine and come to terms with the new “normal” of the new economic order. While pundits and politicians announce that the “world has changed,” the details of those changes are rarely delineated.
The “Lite Economy” less risk taking and less consuming…
The new “normal” is likely to reflect elements of lower risk taking and less spending. I have dubbed the new normal as the “Lite Economy.”
Reduced risk and lower consumer spending form the bedrock of the Lite Economy. Those factors will spawn more conservative practices by business and an increased savings rate on the part of consumers.
Businesses sidestep risk
The business community and consumers are expected to show a propensity to avoid risk or a least keep it to a minimum. Tolerance of risk will be significantly less than the prevailing risk tolerance that prevailed during the past quarter century.
Businesses likely will pursue strategic goals framed by lower debt levels which will create more conservative balance sheets. The Boy Scout motto of “Be Prepared” could replace the “Just Do It” approach to risk. Of course, some of the reduced debt will be a result of tighter credit as banks and other financial institutions adopt stricter lending standards.
New investment vehicles to emerge
The shape and style of investment instruments can be expected to have a “new look.” New investment vehicles are likely to be created by banks and financial institutions in response to the lower risk approach that businesses and consumers adopt. While high returns from high risk instruments will be available, such vehicles will reflect a smaller percentage of all investments.
Demand will increase for consistent returns:
• The return of federal savings bonds may satisfy demand for less risky investment instruments, and they would help to reduce the price of money the government will have to pay to finance the nation’s swollen federal debt.
• The market for mortgage-backed securities will shrink as a result of lower demand. Many investors will avoid mortgage-backed securities, given their risky nature and questionable liquidity.
• As states struggle with their debt levels, some may use the IOU system of registered warrants that California has pioneered. Because these warrants are not immediately payable, they can not be borrowed against or recognized as deposits in a checking account.
Consumers spend less and save more
Robust consumer spending has and will continue to be one the major casualties of the financial and economic upheaval. A higher personal savings rate is a major benefit from the economic turmoil that has rocked consumer behavior.
When consumers begin to show sustained spending, it will be at a lower pace than prior to the recession. One of the most detailed and compelling arguments for lower consumer spending is contained in a report—U.S. Household Deleveraging and Future Consumption Growth —that recently has emerged from the San Francisco Federal Reserve Bank.
The report examines consumer spending by looking at U.S. household leverage, as measured by the ratio of debt to personal disposable income. By this measure, U.S. household debt—as measured by leverage—increased modestly from 55 percent in 1960 to 65 percent by the mid-1980s. Beginning in 2000, the pace of debt accumulation accelerated dramatically. Much of the run-up in debt was mortgage-related. During the decade, a combination of factors including low interest rates, weak lending standards, the spread of exotic mortgages, and the growth of a global market for securitized loans promoted increased borrowing.
Household debt—as reflected in leverage—more than doubled over a period of 20 years, reaching an all-time high of 133 percent in 2007. That dramatic rise in debt was accompanied by a steady decline in the personal saving rate.
The decline in the saving rate was driven, at least in part, by consumers plowing their money into escalating home prices. As such, the price declines in homes can be expected to initiate a sustained rebound in the saving rate over time.
Consumers lower their debt levels
Consumers have responded to the recession and economic upheaval by reducing their debt and increasing their savings.
Consumer debt—both revolving and non-revolving has nosedived since the autumn 2008, following years of increases. The April decline in consumer credit of $17.3 billion was followed by an $8.8 billion decrease in May, a $15.5 billion drop in June and a huge $21.6 billion plunge in July. Those trends can be expected to continue until consumers have reached a debt level in line with income.
Thus, over the long-term, consumer spending will remain at a lower level than in the past quarter century. Concerns about future job security and the memory of foreclosures during the recession can be expected to spur consumers to boost their precautionary saving. Moreover, the need to rebuild nest eggs held for college education or retirement will prompt consumers to shift toward a more saving-oriented lifestyle.
The housing sector in the Lite Economy
The housing bubble burst in 2006. Since then, wealth tied to residential housing has declined dramatically.
In the Lite Economy, lenders will tighten lending standards to require more income, collateral, and documentation for any given loan. A 15% to 20% down payment may be the new norm to purchase a home.
Smaller and lower priced homes—rather than the McMansions of the housing boom—will be a driving factor for sales. Baby boomers looking to downsize as they grow older will create downward pressure on prices of huge, upscale homes.
Price appreciation will be lower than the inflated returns fueled by toxic mortgage-backed securities, because homebuyer demand will be lower given the tighter lending criteria. Demand for homes will be determined by an individual’s lifestyle. Homes will no longer be used as investment vehicles. The percentage of renters will increase, although the rate of return on rental properties will decline from the current level. The housing sector will shrink as fewer people qualify for mortgages and even fewer use their homes as a primary method of investment. The confluence of these factors will create a downward shift in consumer spending on a long-term basis.
Life in the Lite Economy
Lifestyle norms will adjust to the economic forces associated with demand for lower risk and a pattern of more modest consumer spending. An economy marked by consumers who save more and spend less will feature both old and new hallmarks.
• Downsized vacations. Vacations will be more modest and leisure activities will become more home-based and home-focused. Americans will take fewer vacations or at least vacations nearer to home. Extravagant, overseas travel for a vacation may be constrained by household income levels as well as a long-term weakening of the US dollar. Elder-hostel vacations for baby boomers and camping trips for families will children will become more popular, and businesses that are associated with those modest vacations will enjoy higher sales and profits.
• Drivers demand fuel-efficient autos at lower price points. The auto industry will experience major changes as demand increases for lower cost new cars. Demand for used cars will rise in the face of tighter credit conditions and an overall penchant for reduced spending and consumer debt levels. As the quality of autos increases, car owners will keep their vehicles for a longer period of time. Auto repair and maintenance businesses will benefit from that trend. All this will mean lower auto sales in the US. Auto companies will be more dependent on sales outside the US as a result of economic growth among the middle classes in countries such as China and Brazil
• Job growth will be dampened. Higher unemployment rates and less robust job creation may be a permanent condition of the Lite Economy. The U.S. labor market is always in flux as workers leave or find jobs and employers lay-off or hire workers. The relationship between entering and leaving the labor market has varied over time. The 1970’s and 1980’s recessions were characterized by almost equal increases in the inflow rate and declines in the outflow rate.
The earlier trends changed notably in the 1991 and 2001 recessions. The main factors behind rising unemployment rates were declines in the outflow rate, not increases in the inflow rate. In other words, lack of hiring rather than high rates of firing was a key in boosting the unemployment rate. In contrast to the 1970s and 1980s, jobless recoveries followed the recessions of 1991 and 2001.
During the current recession, both the inflow and outflow rates have shifted significantly, with high levels of firing and low levels of hiring, similar to what was observed in the 1970s and 1980s. The outflow rate is at a historically low point, meaning that the unemployed find it very difficult to get work and average unemployment spells are getting much longer. At the same time, the recent increase in the inflow rate is comparable to what was observed in the 1970s and 1980s. These factors combined are creating especially weak labor market conditions that may become the norm rather than the exception.
Debt eeduction stifles growth
Lower debt and consumer spending and higher savings will reduce growth in most areas. A rise in the saving rate would reduce annual consumption growth each year. Such a subtraction from consumption growth would act as a long-term drag on overall economic activity.
Higher savings rates cushion impact of swollen federal deficit
One huge beneficiary of a higher saving rate is the federal government. Certainly, some savings will flow into equities and corporate debt instruments. Many investors will turn to less risky investments backed by the federal government. Demand for government bonds, notes and short-term paper will help to hold interest rates at relatively low levels. US individual investors will offset—in part—the role played by overseas investing nations such as China. That will be a critical factor in the government’s ability to finance its deficits without bringing the US to the status of a bankrupt nation.
The government’s role in the Lite Economy
The debate concerning the role and size of the federal government will continue as it has since Thomas Jefferson advocated a limited government role and Alexander Hamilton promoted a government with greater power, particularly in the realm of money and finance.
Over the country’s history, the Hamiltonian view of government playing a central role in economic matters has predominated. That trend can be expected to continue. Certainly, the call by individuals for increased federal government regulation of the financial services industry is loud and unrelenting outside of Wall Street.
An expansion of federal power may be a necessity for the economy to prosper, because a lower level of consumer spending must be offset with some other growth factor. Exports can be one counter-balance, but even a massive increase in US exporting will only go so far to absorb the impact of consumer spending, which has been responsible for almost 70% of GDP.
Federal spending and investment remains one of the few areas that could propel future growth. The ability to finance the rising federal debt is the key whether government spending can expand without triggering inflation and clobbering the value of the dollar.
In an ironic turn of events, the role of the nation’s citizens—not the government—may prove to be the most powerful force in the Lite Economy. In the past, consumer spending fueled economic growth. In the future, consumer savings may be the engine for growth because it will be the foundation of the government’s ability to finance its spending and investment.