When You're Flush, But Acting Flat Broke
Thursday, April 16, 2009
Denise Kimberlin and her husband, Craig, of Woodbridge are government contractors who make nice livings. They recently got raises. They don't fear losing their jobs.
Yet, something is driving them to change their spending habits. They have cut back by at least $250 a week on clothes, dinners out and other discretionary spending.
So, too, has Bob Scanlon, a Brookeville executive with the Transportation Security Administration. He feels his job is secure. But recently he decided to lop $50 a month off his family's cable bill. When they dine at their favorite restaurant, they go on half-price Tuesdays.
The frugality of the Kimberlins and Scanlons and millions of other Americans who still have their good jobs feed back on the economy, holding down growth and encouraging other worried workers to trim their spending -- causing the whole vicious cycle to run another lap.
"It really can become and does become a self-fulfilling prophecy," Denise Kimberlin said.
Economists say many still-flush consumers are handcuffed by psychological traps that cause them to tighten their purse strings even though economic hardship is not their reality. Underscoring the crucial role that consumer psychology will play in turning around the economy, President Obama and Federal Reserve Chairman Ben S. Bernanke have both been on the hustings this week sounding notes of optimism.
"Traditional economics assumes that we are all rational, that we approach these things very rationally, take in all the information, and then weight it and make a decision," said Thomas Gilovich, a Cornell psychologist and co-director of the university's Center for Behavioral Economics and Decision Research. "To a behavioral economist that seems clearly untrue."
Denise Kimberlin said she began cutting back after the holidays, when at family gatherings and work parties she heard stories of people losing their jobs and people saving money around the edges. The stories made her wonder, "What if?"
These perceptions are reinforced by the blare of the news media. When network news anchors Brian Williams and Charlie Gibson lead their broadcasts with bleak news about the economy and consumers clamming up, people who don't necessarily need to cut back decide to anyway.
In August, the three major TV network newscasts spent a total of 85 minutes covering economic news, according to the Tyndall Report, which monitors newscast content. In September, when the banking crisis began and layoffs spiked, the coverage totaled 403 minutes. In the same month, Gallup's polling shows upper-income consumers dropped their total daily spending to about $160, from a high of $185 in May.
By last month, after what must feel like an eternity of stories about creative ways strapped people are saving money, they had cut back further -- to $101 day.
In 2006, as the economy roared, almost 80 percent of all discretionary income was controlled by households earning more than $100,000, according to the Conference Board. But Gallup recently released polling data showing that since September, per day spending by people making more than $90,000 has fallen by nearly 40 percent. The confidence of wealthy individuals, who considered themselves savvy investors, has been shattered by the meltdown of safe investments. They have seen once-reputable figures like Bernard L. Madoff turn out to be shams and consistently strong bank stocks collapse.
"We have a lack of spending right now in the economy, but it's the pronounced lack of spending by upper-income consumers that has had a major overall impact on what's taken place," Gallup Chief Economist Dennis Jacobe said.
Even the super-rich follow right along. Rapper Ice-T, the star of hit TV show Law & Order: Special Victims Unit, told New York magazine recently at a party to celebrate the launch of a new Louis Vuitton product: "This year we're like, let's spend a little less, not splurge."
Psychologists explain that people fall prey to what is known as social proof. The most famous study pointing at the effect was done in the 1960s by psychologist Stanley Milgram. He had one or two people stand on a busy city block in New York and stare up at a sixth-floor building window. Most pedestrians ignored them. But when he had 15 people stand and stare at the window, nearly everyone walking down the street looked up at it, too.
The phenomenon is at work now, said Robert Cialdini, an Arizona State University psychologist and expert on persuasion. "When people are uncertain, a funny thing happens: they don't look inside for answers anymore because all they see is confusion," he said. "They look to see what other people in this situation are doing. That's a way to reduce my uncertainty about what I should be doing."
Something else is holding back those who could still spend. Many of these consumers saw investments in their homes or stock portfolios shoot up in boom times without much effort. Their personal balance sheets ballooned by double-digit percentages. This made it easier to spend. But when home value falls and stock holdings tank, "people just curl up into a ball," said Richard Thaler, the University of Chicago economist who first identified what is known as the house money effect.
Under the theory, it's easier to gamble, or spend, money when it is earned without having to do much work.
"It's not the absolute money that you have, but the whole history of how you got it," said George Loewenstein, a professor of economics and psychology at Carnegie Mellon University.
The could-spend-if-they-want-to consumers now find themselves caught in a negative feedback loop. In a recent Gallup report on consumer moods, the organization found that a year ago upper-income Americans were more optimistic than lower-income earners, but the positions have switched. But how -- and when -- will these consumers break free?
"What eventually happens is that these feedback loops drive prices below fundamentals," said Loewenstein, implying that the bargains become just too good to resist. "All of the sudden there will be these amazing values out there -- real estate values, stock values." But in this environment of falling values, it is increasingly difficult to determine what is a bargain-basement price and when the declines will stop.
Cialdini, the Arizona State psychologist, said consumers experiencing the look-up-at-the-window phenomenon often look to what experts say they should do. So if, for instance, the majority of experts say the economy is turning a corner and it's okay to spend, "that can break the cycle," he said.
But Denise Kimberlin, the government contractor, doesn't think she will be looking at what the experts say. She is looking for signals from the same people whose experiences caused her to fasten her pocketbook to begin with. "When someone I know actually finds a new job," she said. "I haven't seen that. I haven't seen that in months. That would be a good sign."