Economy Losing Its Cushion


The resilience of the U.S. economy, which rebounded from wars, terror attacks and a crash in tech stocks in the past quarter century, has been weakened in the aftermath of the housing bust, and shock absorbers that cushioned blows in the past are no longer working.

The government on Friday reported that the economy grew at a rate of just 1.3% in the second quarter, failing to bounce back from knocks earlier in the year. Estimates of first-quarter growth were also revised down to 0.4%. As a result, the pace of economic recovery has been one of the worst since World War II, weaker than all but the short-lived recovery of the early 1980s. That’s particularly bad news as the economy confronts the threat of a default on the nation’s debt.

Among the reasons the economy is so vulnerable: Debt-laden consumers with scant savings are prone to slash spending when their incomes drop. Household confidence is more fragile. Individuals are moving less often to find jobs, making it harder for firms to fill vacancies. And the government, for decades the rescuer of last resort with interest-rate cuts, tax reductions and spending increases, has run out of string.

Economists label the late 1980s, 1990s and early 2000s “The Great Moderation,” a period in which the ups and downs of the economy were muted. That epoch is over. James Stock, a Harvard economist who helped coin that label, says that the volatility of economic output, income and consumption looks more like it did 25 years ago. “In this recession and its aftermath, those smoothing mechanisms, those shock absorbers, clearly have been damaged,” he says.

The U.S. economy has been expanding for two years now, and forecasters had been expecting it to pick up steam in the second half, powered by robust overseas demand, investment at home by cash-rich companies and a renewed willingness of consumers to spend as they reduce their debt burdens. But Friday’s GDP report and the impact of Washington’s debt-ceiling stalemate on consumer and business confidence as well as on financial markets are raising doubts about that outlook.

It could be years before Americans feel that they’ve pared enough debt to start spending readily. Household debt levels, at 112% of annual income, remain high. To get back to a 1990s debt-to-income ratio of 84%, incomes would need to be nearly $4 trillion higher, which is about nine years worth of income growth, according to Credit Suisse estimates.

The U.S. economy was hit hard earlier this year by shocks. The earthquake in Japan disrupted auto production in the U.S. The Middle East turmoil drove up oil prices. U.S. consumer spending, adjusted for inflation, actually fell in April and May, which is unusual.

“We were anticipating that 2011 was going to be a fairly decent year,” says Robert Olson, chairman of Winnebago Industries, the recreational-vehicle maker. “We hit February and it really felt like people flicked a light switch.” Now, Winnebago is holding off on parts and equipment orders to work down a $33 million buildup in inventories.

Debt is central to the fragility. The ability to borrow in bad times helped limit the economy’s bumps in the 1990s and early 2000s. Karen Dynan, an economist at the Brookings Institution, a Washington think tank, says that, on average, a $100 short-term hit to incomes only pushed spending down by $5 during that stretch because consumers could borrow to smooth things out. Now, she says, they’re stretched too thin to do that.

“I’m running out of things to cut,” says Pat Sonnek, 50 years old, of Gibbon, Minn. Five years ago, Mr. Sonnek lost his job programming mainframe computers. So he earned an online degree, got into accounting and took cash out of his home to help make ends meet during the transition.

Today he has a $110,000 mortgage to pay off on a home worth less than that and $80,000 in student loans coming due. He is making $36,000 a year as an accountant for a small Internet retailer, less than half the $80,000 he made before. He commutes 55 miles to work every day, which meant rising gas prices “hit pretty hard.” He and his wife, who has a part-time job as a school custodian, have gotten rid of their landline telephone, cable-television service and cut back on fresh fruits and vegetables. If he needed a few thousand dollars now, he says, “I’d have to go begging to friends and family.”


Robert Hall, a Stanford University professor, finds that three-quarters of households don’t have two months worth of income socked away as cash or other liquid assets. Federal Reserve researcher Karen Pence finds that 41% of households can borrow less than $3,000 on their credit cards and 23% have been turned down or discouraged from applying for credit.

In March 2001, as a recession began, 40% of those surveyed by the University of Michigan felt they would be better off financially in a year. By the end of the year, even after the Sept. 11 terror attacks, the measure of optimism had risen to 45%.

Confidence has been less resilient recently. In February, 30% said they expected to be better off financially in a year; in July, it was 20%, an all-time low.

When bad news hits today, individuals and businesses are less apt to keep spending. Both their spirits and their savings are spent.

“I’m totally discouraged,” says Tanya Griffin, 53. After eight months of unemployment, she took a job as a $150,000-a-year manager of product development for a large retailer in Boston. Now she commutes across country because she can’t sell the Issaquah, Wash., home where her children—ages 16, 18 and 21—are still living.

She pays roughly $4,000 a month there between the mortgage and upkeep, plus rent in Boston. “It’s pretty much living paycheck to paycheck,” she says. With no savings left to fall back on, she is cutting back on clothes, sporting activities for her children and eating out.

Other workers aren’t moving to where jobs are. In 2009, 2.9 million U.S. households moved for a new job or a job transfer, the Census Bureau said, down from 4.5 million a decade earlier.

One reason is they can’t. Eliseo Otero, 40, planned to leave Las Vegas in 2010. A $61,000-a-year civil engineer who drafted computer plans for roadways and construction subdivisions, he lost his job in 2008. Since then, he has been making $9,000 to $15,000 a year as a security guard and temporary staff worker for Vegas events. The dream of leaving, he says, is shot because of a $200,000 mortgage on a home he can’t sell.

Trussbilt LLC, which makes security products for correctional facilities, says it can’t get workers to come to Huron, S.D., where the firm has manufacturing facilities and the unemployment rate is less than 5%. In August 2008, Eric Christensen, vice president for finance. recruited about a dozen workers from Elkhart, Ind., where unemployment was 9% and rising. They all ended up returning home after a stint in South Dakota, in part because they were tied to families that couldn’t move and homes they couldn’t sell, he says.

Meantime, the government’s ability to serve as a shock absorber is crimped. In 2003, when an economic recovery stumbled, the Bush administration pushed through tax cuts to get cash into the hands of households and the Fed pushed down interest rates to ease borrowing. In 2008 and 2009, the Obama administration and the Fed did it again, boosting federal spending in an $800-billion stimulus and cutting interest rates to near zero.

Now, with deficits high, the federal government is moving toward cutting spending. The Fed, which can’t cut short-term rates below zero, is reluctant to pursue another round of buying mortgages and Treasury securities to push down long-term interest rates and stimulate growth.

Write to Jon Hilsenrath at and Sara Murray at