Op-Ed: The Great Retail Die-Off
The American consumer is in a state of suspended animation.
Minyanville Staff
Mar 03, 2009 10:10 am
Editor's Note: James Quinn is a senior director of strategic planning for a major university. James has held high-level financial positions with a retailer, homebuilder and a university in his 22-year career.
Politicians, bureaucrats and financial pundits are breathlessly awaiting the return of irrational exuberance. They believe American consumers just need a little confidence to resume their rightful place at the top of the economic pyramid. I hate to be a wet blanket - but the American consumer isn’t coming back. The burden of debt, continuing home price depreciation, lack of savings, and the aging of America will change the face of retailing for decades to come.
In February, the Consumer Confidence Index was 25, the lowest since its inception in 1967. During the dot-com bubble, it reached an irrationally exuberant 140 and hovered at the 110 level until late 2007. The good news: It can’t go below zero. But with an unemployment rate of 7.6% and rising, consumers aren’t likely to become confident again anytime soon.
The country has tried to spend its way to prosperity over the last 3 decades. Total consumer debt is just under $2.6 trillion, or $23,600 per household, including credit-card debt, auto loans, and personal loans. There are approximately 170 million credit-card holders and 1.5 billion cards - or approximately 9 cards per person. The average household carries nearly $8,700 in credit card debt. The average new car loan is $25,000, with a loan-to-value ratio of 93%. This means the average new car owner is underwater from the moment he pulls out of the dealership.
Only 23% of the credit cards in the country are in the hands of prime borrowers. According to Fitch, write-offs are breaching 8%, and will reach 10%. Auto loan delinquencies are already at 10%. Guess who will step up to the plate and cover these losses? We will.
Consumer credit ranged between 12% and 14% of the GDP from 1965 through 1995. It currently stands at 18%. With the GDP at $14 trillion, the American consumer will have to shed $600 billion of debt to achieve a 14% level. It will take years of debt reduction and GDP growth to rebalance the economy.
US households accumulated an additional $8 trillion in debt over the past decade. As home values rose relentlessly, saving for retirement became passé. Our housing wealth would take care of us in our old age, we thought, and the savings rate went negative.
Average Americans are getting serious about reducing spending and increasing savings. Now, Americans are left with 45% equity in their homes versus 68% in 1985. With home prices destined to fall another 20% to 30%, equity will fall to 35%. One in 7 homeowners across the country has negative equity; of homeowners who bought in the last 5 years, 29.5% are under water.
Between 2002 and 2008, Americans sucked over $3 trillion of equity out of their houses. But that well is now dry: The savings rate jumped to 5% in January, the highest level since 1995. This trend will continue, and could reach 10% in the coming years. The number of homes for sale is still at record levels. With foreclosures accelerating, more houses will hit the market, and prices will fall. There are 2.1 million vacant homes in the US today - 1 million more than the historical trend. No one is going to buy them at their current asking prices, and the government’s efforts to mitigate foreclosures and prop up home prices with our tax dollars will fail. With prices falling for another 2 years and jobs disappearing at a rate of 500,000 per month, consumers may stay on the sidelines for years.
It will likely take 10 years to get back to break-even on the portfolio losses we’ve experienced in the last 18 months. Anyone who’s retired in the last 5 years or had plans to do so in the next 5 years has had his plans upended. They’ll have to go back to work, or keep working longer - provided they can find jobs.
The drop in retail sales in the last few months is the most dramatic in US history. This isn’t a momentary blip; it’s a paradigm shift. From 1952 through 1982, consumer spending as a percentage of our economy ranged between 60% and 64%. In 2008, this ratio topped out at close to 71%, or $10 trillion of our $14 trillion economy. Since this was an unsustainable trend, it will revert to the mean over the next decade. The reversion to 62% of GDP will reduce consumer spending by $1.3 trillion annually going forward.
To paraphrase John Paul Jones, we’ve only just begun to de-lever. When you accumulate debt over 3 decades, you don’t get rid of it in 2 years. Multi-decade expansions of debt are followed by a multi-decade deleveraging. The consumer is in the process of collapsing, and the retail industry will be devastated by this paradigm shift. Most retailers in the United States aren’t prepared for $1.3 trillion fewer consumer dollars per year. Their expansion models were built upon existing demand, extrapolated at 5% or greater growth for eternity.
The good news: Retailers’ flawed expansion models won’t bring down the financial system. The bad news: Thousands of retailers will go bankrupt.
Retailers are famous for their copycat management strategies. Wal-Mart's (WMT)concentration strategy has inspired a host of imitators (think of Target (TGT), or Kmart (SHLD), or big-box stalwarts like Best Buy (BBY)). But there are 3 major errors that virtually every retailer in America has committed: They failed to recognize that spending per household was over-inflated 30% due to debt-financed demand. Second, they extrapolated the spending per household using a 5% to 10% growth rate. Lastly, they ignored the fact that their competitors had done the same thing.
Many retailers have a winning concept, but few have top executives who truly understand their external environment, their competitors and changing trends. All are essential to long-term success. The accumulation of bad strategic decisions by management will eventually bankrupt even the best retail concept.
Any executive planning for an upturn in consumer spending next year is in for a rude awakening. The environment has changed forever; if they don’t adapt immediately, their companies will die. Balance sheets continue to deteriorate, and retailers with huge short-term debt obligations run the risk of not being able to roll over that debt. Many retailers won’t be in business 5 years from now. Others will need to close hundreds of stores to survive.
All glory is fleeting. The American conquerors have returned from the mall wars pulling carts laden with HDTVs, iPods, Rolexes and other treasures. But there’s no powder left to fight another war.
No positions in stocks mentioned.
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