Nouriel Roubini, Professor of Economics at New York University’s Stern School of Business, has outlined 20 reasons why the recent drop in retail sales (-2.8 percent in October) is not a temporary phenomenon, but rather an early signal of a persistent decline in consumer spending that will drive the United States, and the world, into one of the worst recessions any of us has ever seen.

The analysis can be broken down into three categories: Unsustainable Consumer Debt Ratios; Falling Housing Prices; and Poor Savings Rates.

Unsustainable Consumer Debt Ratios

Professor Roubini writes:

The US consumer is debt burdened with the debt to disposable income having increased from 70% in the early 1990s to 100% in 2000 and to 140% in 2008. Not only debt ratios are high and rising but debt servicing ratios are also high and rising having gone from 11% in 2000 to almost 15% now as the interest rate on mortgages and consumer debt is resetting at higher levels.

Now, add an economic environment where jobs are becoming scarce and the threat losing one’s employment is very real (Citibank just announced an additional 53,000 layoffs today) and the reaction of consumers who owe more than they earn is not hard to figure out—they will stop spending altogether.

Falling Housing Prices

Roubini:

The value of housing wealth is now sharply falling by over $6 trillion as home price depreciation will soon be 30% and reach a cumulative fall of over 40% by 2010. Recent estimates of this wealth effect suggest that the effect may be closer to 12-14% rather than the historical 5-7%. And with home prices falling over 30% about 40% of all households with a mortgage (or 21 million out of 50 who have a mortgage) will be under water (negative equity in their homes) with a huge incentive to walk away from their homes.

Mortgage equity withdrawal (MEW) is collapsing from $700 billion annualized in 2005 to less than $20 billion in Q2 of this year. Thus, with falling housing wealth and collapsing MEH US households cannot use their homes anymore as ATM machines borrowing against them.

The value of the equity wealth of US households has fallen by almost 50%, another ugly wealth effect on consumption.

The credit crunch is becoming more severe as the recent Q2 flow of funds data and the Fed Loan Officers’ Survey suggests: it is spreading from sub-prime to near prime to prime mortgages and home equity loans; and from mortgages to credit cards, auto loans and student loans. Both the price and the quantity of credit are sharply tightening.

The point here is that, in other recessions that we have experienced, falling housing prices made consumers “feel” poorer, so spending declined temporarily.  This time around, consumers really are poorer as a result of falling real estate prices because prices had shot up so high above the long-term trend line during the last few years.  All of the home equity that consumers borrowed against to pay their debts, buy a car, send their kids to college, etc., is gone.  Not only that, but many consumers now owe more on their mortgage than their home is worth.  On top of that, even those who have equity to borrow against cannot get a loan, or to the extent that they can, it is much more expensive to borrow now.

Poor Savings Rates

Roubini:

To bring back the household savings rate to the level of a decade ago (about 6% of GDP) consumption will have to fall – relative to current GDP levels – by almost a trillion dollars. If all of this adjustment were to occur in 12 months GDP would contract directly by 7% and indirectly (including the further collapse of residential and corporate capex spending in a severe recession) by 10%, an exemplification of the Keynesian “paradox of thrift”. If such an adjustment were to occur over 24 months rather than 12 months you would still have negative GDP growth of 5% for two years in a row with a cumulative fall in GDP from its peak of 10% (note that in the worst US recession since WWII such cumulative fall in GDP was only 3.7% in 1957-58). One can thus only hope that this adjustment of consumption and savings rates occurs only slowly over time – four years rather than two. Even in that scenario the cumulative fall of GDP could be of the order of 4-5%, i.e. the worst US recession since WWII. Note that the cumulative fall in GDP in the 2001 recession was only 0.4% and in the 1990-9 recession was only 1.3%. So, the current recession may end up being three times as long and at least three times as deep (in terms of output contraction) than the last two and worse than any other post WWII recession.

The bottom line is that our economic growth during the last 10 years was fueled almost entirely by debt.  Now, in order to restore the U.S. consumer to a net saver, as we should all be, we must endure a great deal of pain.  Our tremendous spending habits have come home to roost, and now the butcher’s bill is due.  The TV talking heads and pseudo-academics benignly refer to this as “deleveraging.”

[SOURCE: 20 Reasons Why the U.S. Consumer is Capitulating, Thus Triggering the Worst U.S. Recession in Decades, Nouriel Roubini, RGE Monitor.com.]