State of Business in America

By Miriam Hill

Foreclosures are at record levels, threatening thousands of homeowners with eviction. More workers have joined the unemployment line. Grocery bills are rising, and Goldman Sachs is predicting that oil could hit $200 a barrel in a few years. “Stagflation” has reentered the national vocabulary.

It’s starting to feel like the 1970s all over again. Or is it?

The 20,000 jobs the economy lost in April was not as bad as expected, and the unemployment rate of 5 percent remains low by historical standards. Retailers are suffering, but consumers are still filling their shopping carts: Costco Wholesale Corp. and Wal-Mart Stores reported better-than-expected April sales.

At Wharton, professors pore over business data to divine where the economy is headed. In late spring, we asked six of them to weigh in on housing, the Fed’s recent behavior, and whether it’s fair to call this downturn a recession, among other topics. Their varied opinions follow.

Susan M. Wachter

Richard B. Worley Professor of Financial Management

When it comes to real estate, Wachter both sets and follows trends. She founded and directs the Wharton GIS Lab, which specializes in Geographic Information Systems, a technology that combines geographic, economic, and other data to study everything from land use to foreclosure rates in various neighborhoods.

Her GIS work led President Clinton to choose her to be his assistant secretary for policy development and research at the U.S. Department of Housing and Urban Development, a position she held for two years until President Bush took office in 2001.

Most people take the rebirth of urban America as a given now, but Wachter never stopped believing, even when the words urban and decay were frequently partnered. As policymaker, researcher, and professor, she pushed for reinvestment in urban areas. Now that the housing boom has turned into a bust in some areas, Wachter can often be found discussing these ups and downs on ABC News and in the New York Times.

Q. How big is the housing problem?

A. Estimates have been that it will reduce GDP by about 1 percent, but the key question is whether we’re going to get out of the subprime crisis without a recession. We don’t know. The next six months will be very telling.

Q. The housing market has been in decline for more than a year. Why does so much uncertainty remain?

A. In some ways, we are in very, very uncharted territory. In fact, we have to go back to the Great Depression to find a period of decline in housing prices as great as we have now.

Here are the two big questions: As prices decline, will homeowners and potential buyers react by going on a buyers’ strike in the expectation that prices will fall further? If so, will this have a self-reinforcing impact? One thing we do know is that on the upside, rising prices are self-reinforcing, and that is what gives rise to bubbles.

Secondly, as prices decline in the normal housing market, demand increases and you get to a point where demand absorbs excess supply. But what we are in is a situation where as prices decline, supply increases. New housing starts are down, but our current situation generates supply increases through increases in foreclosures. No one really has good estimates of the impact of this.

Moreover, there’s a possibility for the overall economic slowdown to feed into the housing decline and for housing decline to feed back into the overall economic decline.

As prices fall, if you’re not forced to sell, you may simply wait it out. We’ve already had a 15 percent price decline, according to (Standard & Poor’s) Case-Shiller National Home Price Index. Foreclosure sales have been an unusually large percentage of the last quarter’s sales; there will be more sales generated from the usual market forces from springtime and this may lead to a moderating of the price decline. Whether owners will hold on and prices will moderate or whether we will continue to see the disproportionate impact of foreclosure sales depends on lender behavior as well as policy inducements to encourage loan work-outs.

There are more than 10 million homes in the United States where the value, based on current mark to market, is less than what is owed. It’s a stunning number, but its economic impact depends on how these homeowners respond, and whether they act on knowledge that their home value is beneath their mortgage amount.

We do know that typically homeowners do not monitor the value of their homes, nor do they typically get up and walk away. People are invested in their homes, invested in their neighborhoods. Nonetheless, there is the potential of a downward spiral, which is why the Federal Reserve eased credit — to minimize the danger of the resetting of so-called teaser rates. By getting short-term interest rates down substantially that particular bullet has been avoided.

Q. You mentioned earlier that we have to go back to the Great Depression to find comparable declines in the housing market. But how well does the current period compare? Haven’t the housing market and the overall economy changed dramatically?

A. We’re only using that as a way to say we’re in uncharted territory. Fed Chairman Ben Bernanke is an expert on the Great Depression, which explains his very quick reaction to the credit crisis.

In some ways the markets do compare. Then, too, we had loans that could not be refinanced when they came due, so-called bullet loans. The major difference is that upwards of 25 percent of mortgages were in default. Today, we see defaults at 6 percent.

Also, this is a regionally based housing recession. What were the drivers of the subprime crisis? One was lower middle- income and working-class borrowers who had a hard time affording a house, including the Midwest where the job market is weak. So wherever credit was imperfect, where people had low credit scores, subprime expanded, sometimes with these toxic, aggressive loans.

And in coastal states, where housing was not affordable, subprime loans offered a way to get people into houses. Much will depend on the course of the regions as well as the national economy.

Q. So are there solutions to the housing crisis?

A. Bernanke has eased monetary policy and stabilized financial markets to some degree. Going forward, inflation is a real issue, so there are limits to what can be done. At some point inflation expectations start to drive up interest rates. There’s not a lot of room here for getting it wrong.

There are targeted responses as well, such as those that were put into place after the Savings and Loan crisis and the Great Depression. In the latter case, the government stepped in to put a floor on the decline on housing prices. Congress is currently considering legislation that would work in this direction, but issues of who pays and consequences for future risk taking are also being weighed.

Q. Some experts say lenders should be working harder to negotiate with borrowers who are behind in their loans. These people say it’s often cheaper to modify a loan than to go through foreclosure and sell a house at a loss.

A. A real problem is borrowers making the connection with the lender. This problem can grow if you don’t get it early, so that first connection is crucial. If you can make the connection and modify the loan then often that is best for the borrower and the lender. But if in the end, foreclosure is going to happen, if the economics will not allow them to be in the house long-term, it doesn’t do a favor to the borrower to prolong the process. There is also an issue of conflicting interests on the parts of the multiple holders of mortgage securities that needs to be resolved for fast action to be taken. Moreover, from a production perspective, this is a difficult time. Mortgage servicers are overwhelmed and simply lack staff to get borrowers to the table and negotiate solutions.

But, if this is a self-reinforcing process, what do you do? What will it do to cities? What will it do to neighborhoods? This is at the heart of the current policy discussions.

Q. The last time we experienced a downturn in the housing market was in the 1980s. Many experts have said that markets hardest hit during that period — Boston, California — recovered. Does that offer any comparisons to today?

A. Cyclic markets like Boston and California recovered. They were down 30 percent in nominal terms and they came back. So in this run-up, prices exceeded previous highs of the mid-1980s substantially. These are very volatile markets because supply is constrained and once prices start to rise there’s an expectational component that itself drives demand, which can quickly reverse.

The price dynamics are different in what I call the flat-liners — the markets where housing prices just keep pace with inflation — places like Texas where despite tremendous increases in demand, prices did not increase. Supply did. The problem is that much of the United States has become more volatile. Texas is the exception — supply constraints add to price volatility.

Markets will be weighed down by inventory of new production and foreclosed homes now on the market. Before recovery can begin, we need to stanch the increase in inventory. We are not there yet. This crisis is the inevitable result of financial markets flooding the housing sector with capital without regard to underwriting standards and then withdrawing funding after unsustainable price run-ups. Mortgage-market cyclicality is now a key to the problem and the part that we need to resolve longer term.

For more from Wachter on the subprime mess, see additional coverage in Knowledge@Wharton at

Franklin Allen

Nippon Life Professor of Finance and Co-Director of the Wharton Financial Institutions Center

Franklin Allen chases economic storms the way some people chase tornadoes. Financial crises are one of his research specialties, along with corporate finance. In the classroom, his ability to cope with calamity won him both the “Whatever It Takes” and the “Above and Beyond the Call of Duty” awards from Wharton. One bit of academic derring-do: When too many students signed up for one class, he simply added a second at 7:30 a.m. and promised breakfast to compensate for the early hour.

When he casts about for answers, he likes to look abroad. One of his other research specialties is comparing different countries’ financial systems. In the following interview, he includes some lessons the United States might learn from Scandinavian central bankers.

Q. Your book, Understanding Financial Crises, considers past crises and crashes. Do you consider the current financial situation a crisis?

A. I think it is a crisis. It’s a protracted one, so it has happened over some time, but yes, I think it is a crisis.

Q. How do you define a crisis?

A. It’s when a situation in the financial markets gets very severe, when you have institutions failing. Bear Stearns is one example. Northern Rock in the U.K. is another. We’ve also seen vast changes in volumes in the credit markets, those kinds of things.

Q. We’ve been coping with these problems for about a year. Are we out of the woods yet?

A. I don’t think yet. I think it will be a lot like Japan. Property prices take a long time to adjust, and they’re still falling. As long as they keep falling, we don’t know what’s going to happen. If property prices go a lot below where these mortgages are, we’re going to have more defaults. That’s what happened in Japan. They thought it was near an end, and it just kept going for 15 years.

Q. Is Japan completely over its problems?

A. No, not yet. They still have the after-effects of it. The big question here is how far property prices will fall. Some people like (Yale University economics professor) Bob Shiller argue that they’ll fall 30 percent. Another big question is, Will there be feedback effects? If unemployment keeps going up, people won’t be able to afford their mortgages. Now hopefully, that won’t happen and we’ll be okay. We’re not going to go 15 years like Japan, but we might go two or three years.

Q. Many people view Federal Reserve intervention in today’s financial situation as unprecedented. What do you think of the Fed’s action, and is it working?

A. We are in a high inflation situation. It may well be that we end up with stagflation, where you have a stagnant economy and inflation, and then they have to raise interest rates. It’s a very difficult situation.

Did they do the right thing? I’m not sure cutting interest rates was the right thing, but where I would have criticized them was with Bear Stearns. I don’t think they should have given the guarantee (of Bear Stearns’s troubled assets) for free. I see why they didn’t want to let the bank go bankrupt, but I don’t think the guarantee was a good precedent to set going forward. I also think there is some truth to the argument that they should have just let them go bankrupt.

Q. You mentioned stagflation earlier. Most people associate that term with the 1970s, when rising oil prices fueled inflation and there was a lot of unemployment. Is today’s situation like that one?

A. Conditions are very different today. I think the reason we have so much inflation today is because China and India need so many resources, which, together with food shortages, have pushed prices higher.

Q. Many banks that were once paragons of lending virtue — National City Corp., for example — have stumbled badly. What happened to credit standards, even at venerable institutions?

A. If you talked to people five years ago, and said there’s a bubble in the housing market, people might have said, “Oh, you might have that in some regional markets, but it’s not a widespread problem.” All these subprime loans were fine as long as housing prices kept going up, because then you could sell the house. The problem comes of course when prices start falling.

Economists have been talking about a bubble for years, but if you look at a lot of stories about housing, you’ll see a lot of, “Here’s why this time is different.” Of course, it never is.

In the United States, people were very surprised to see that house prices could fall. We’ve also had a lot of deregulation that allowed the financial system to make a lot of decisions. Now there are problems.

Q. How long do you think the housing market will remain in a slide? Who will be hurt? Are there any winners?

A. Yeah, the guy that made $3.7 billion running a hedge fund, and there were a lot of other people that made a lot of money shorting these subprime mortgages. But a lot of people have lost, and maybe a lot more will lose going forward.

One of the points that hasn’t been made in the press very much is the fact that the Fed is behind in terms of financial stability. After the crisis in Scandinavia, they started taking financial stability very seriously. They started publishing financial stability reviews. There were about 42 central banks that did. The Federal Reserve doesn’t do that, or at least they don’t bring it all together in one place. I think it is a good discipline to have a group of people who do that. I think it’s something we need to start worrying about. We need to have a group of people that brings together information every six months or so. If they had done that, they might have caught the subprime mortgages, but they might not have.

The other big issue is whether central banks should worry about asset prices. Traditionally, Ben Bernanke and others say the Fed should just worry about consumer prices. And I would argue that we should worry in particular about house prices because they underlie so much of the economy. In Sweden, they consider housing prices when they set interest rates, and here they don’t.

Jeremy Siegel

Russell E. Palmer Professor of Finance

The words “household name” and “business professor” don’t often appear in the same sentence. Unless, of course, that name is Jeremy Siegel. His book, Stocks for the Long Run, has convinced squadrons of investors that stocks generate better returns than any other vehicle over periods of several years or more. Anyone who believes in buying and holding and rides out stock-market downturns rather than selling is a Siegel disciple.

The Washington Post called Stocks for the Long Run one of the 10 best investment books of all time. In 2005, Siegel tweaked his advice in the follow-up book The Future for Investors. Despite the doom and gloom of recent headlines, he remains an optimist. Here’s why:

Q. Many experts, including some of your Wharton colleagues, believe we’re already in a recession, or are definitely headed for one. Why do you remain relatively bullish?

A. First of all, there’s the official recession called by the National Bureau of Economic Research, which we may not know for a year or more. And then there’s the rule of thumb recession, which is defined as two quarters of negative GDP growth, and most experts by a margin of two to one say it’s unlikely that we’re going to have two negative quarters. Last quarter’s growth was slightly positive. All this doesn’t mean we’re not having a slowdown.

Q. So what do you think those who say we’re in a recession are getting wrong?

A. Obviously, they think it’s going to get much worse.

Q. The big question mark in this economy is housing. People fear that declines in housing could have a self-reinforcing effect — people can’t pay mortgages, which aggravates economic downturns and leads to layoffs that then feed into more debt problems. How do you see housing affecting the rest of the economy? Do you worry, as others do, that we just haven’t experienced a housing downturn like this since the Great Depression?

A. This is a very serious decline in residential prices after a rise that was excessive. Many of the people who bought houses in the last few years are underwater. There will be foreclosures, but most lenders are still trying to work things out with the borrowers.

We’re waiting for action from Washington. The number of people who are going to be thrown out of their homes is going to be much smaller than we fear. But don’t forget, most homeowners who bought six or seven years ago are still in the black. In the Great Depression, everybody was affected. Today, we’re really correcting a bubble.

Q. The Great Depression looms over every economic cycle as if people believe there’s a strong possibility that it could happen again. Do you think that’s a legitimate fear?

A. No, because the Fed is standing behind the banks. In the Great Depression, we had runs on banks, and the banks failed. We have nothing like that happening now.

Q. So why do people raise the specter of the Depression so often?

A. Milton Friedman did path-breaking research documenting that the collapse and Great Depression were due to the Federal Reserve’s failure to stand behind the banks. It wasn’t only the slowdown that caused the Great Depression; it was also the Fed’s response to it

Q. What is your opinion of how the Fed has handled the Bear Stearns problem and the credit crisis overall?

A. I would have preferred that the Fed opened up the bidding process for Bear Stearns to all bidders and see what price they could have come up with. But that some sort of rescue package had to take place — with that, I concur.

Q. This is an election year. What effect, if any, do presidential elections have on the stock market? And should people change anything in their portfolios as a result?

A. Well, the truth of the matter is that over the last 50 years stock markets have done better under Democrats than Republicans, even though most big investors are probably Republicans.

I myself would prefer a Republican in office. I like a split between branches of government. I voted for the Libertarian candidate in 2004 because I did not like the way Bush was handling the war in Iraq. I viewed my vote as a protest.

I’m not really that concerned. Even if the Democrats win the White House, they cannot do anything they want. They need 60 votes to end a filibuster in the Senate, and they’re not likely to get that.

Q. More broadly, does anything in the current economic situation, or that you see in the stock market, lead you to suggest portfolio changes?

A. I’m a big fan of international markets. We’re seeing huge growth outside of the United States. You should have 40 percent of your stock portfolio in equities headquartered outside the United States.

For more from Siegel on the current economy, see Knowledge@Wharton and

Richard J. Herring

Jacob Safra Professor of International Banking and Co-Director of the Wharton Financial Institutions Center

The Federal Reserve is fighting a war without the right weapons, Herring says. The war is the credit crunch. As a member of the Shadow Financial Regulatory Committee, a group of independent financial services experts, Herring studies and critiques the industry. These days, the committee is worried. Here, Herring explains why:

Q. How big is the housing problem and what do you think should be done to fix it, if anything?

A. The problem is that we are recovering from a speculative bubble that has left us with a large excess inventory of homes. We don’t know how long it will take to work through this inventory. Much depends on whether we have a long, deep recession and the kinds of government programs that are put in place.

It’s very difficult to design public intervention that won’t exacerbate the problem. It’s hard to separate imprudent borrowers from borrowers who were defrauded, and there is understandable resistance to taxing people who behaved prudently to help people who behaved imprudently. Another feature of the problem that has received too little attention is that housing prices really had gotten too high relative to historical standards, so a large portion of the American population was simply priced out of the market.

I just got back from a meeting of the Shadow Financial Regulatory Committee. We issued a statement on the housing crisis proposing an alternative to consider before using federal money to help borrowers already in or facing foreclosure. This alternative proposal would allow these homeowners to rent their houses for several years with an option to buy at the current price. This would save lenders the costs of foreclosures, let homeowners remain in their homes, and force investors to take some losses. (This statement and others can be viewed on the website of the Wharton Financial Institutions Center at

As for how big the problem is, the International Monetary Fund is projecting total losses of $1 trillion. Relative to GDP, that’s larger than the losses sustained in the S&L crisis.

To some extent it is misleading to generalize about the U.S. housing market. It’s really a series of independent markets loosely linked by migration flows. The U.S. has what Wharton Real Estate Department Chairperson Joe Gyourko calls “superstar cities” that can sustain price increases far out of scale with other parts of America. These cities, like New York or San Francisco, usually have well-defined geographic boundaries and often very tight zoning restrictions that prevent supply from catching up with demand. In other cities, like Las Vegas, geographic constraints are much looser and zoning restrictions are relatively light. In such places prices will inevitably fall to the price of new construction.

Q. What do you think of how the Fed has handled the crisis, including the sale of Bear Stearns?

A. The Fed has been very creative about injecting liquidity into the system in various ways. Unfortunately, liquidity is only part of the problem. The collapse of the market for structured finance has decapitalized a number of banks that are central to the functioning of the financial system. Banks have suffered direct losses from holding downgraded securities, losses from honoring implicit guarantees backing up off-balancesheet vehicles, losses on pipelines of assets that can no longer be securitized, and the loss of a major source of ongoing bank revenue. The capital challenge is immense. Banks need to replace lost capital, stockpile additional capital as a precaution against loss of access to funding, and add new capital to bring at least part of the massive off-balance-sheet banking system back onto the balance sheet. Moreover, there are serious concerns that the broader consumer business will deteriorate.

Q. When you say the broader consumer business is threatened, what do you mean?

A. We know that the problems that began in housing are spreading, in some cases because of pressures that are unrelated to housing, such as rising oil prices and commodity price increases. Traditionally, it’s thought that consumers in a credit crunch will pay their mortgages first, then cars, and then credit cards. Now people are paying credit cards first because if you can’t pay for gas, you can’t get to work and if you can’t keep your car you can’t keep your job and so you’ll lose your house anyway.

It makes sense, also because the foreclosure processes take a lot longer, and you can play for time that way.

Now, back to Bear Stearns. Bear Stearns has been in trouble since its hedge funds blew up in June of 2007. Its share price dropped steeply and credit default swaps indicated increasing anxiety over whether it was still solvent. Rather than rebuild its capital, Bear increased its leverage and reduced its liquidity position. Although the failure should not have been surprising, the speed with which it failed clearly took the authorities off guard. Bear’s prime brokerage specialty, which had been the jewel in its crown, became a liability as hedge funds withdrew their assets and switched to other prime brokers. Some OTC derivatives counterparties sought to replace trades with Bear by new contracts with other dealers. Lenders would not engage in stock lending and tri-party repurchase transactions with Bear. Some banks refused to clear for Bear.

The evaporation of the repo market was perhaps most surprising. Repo is short for repurchase agreement, in which a borrower sells securities for cash to a lender and agrees to repurchase those securities at a later date for more cash. The whole idea behind the repo market was that it enabled a firm to borrow on the strength of its assets rather than on its own credit condition. But this has turned out not to be true for Bear. Bear was highly dependent on third-party term repos. In this case lenders must be sure that the counterparty can put up additional margin should it become necessary over the term of the repo. In the end, the market lost confidence that Bear Stearns could do so.

The Fed crossed an important regulatory Rubicon without the right regulatory weapons. It lent $30 billion to Bear through Bear’s main clearing bank, JPMorgan Chase, and then set up a special purpose entity to hold $30 billion in “investment grade” Bear assets financed by $29 billion from the New York Fed and a $1 billion subordinated note from JPMorgan Chase. All creditors and counterparties of Bear were protected. Apart from the potential cost to taxpayers, the action created unfortunate incentives that will inevitably encourage more risk taking in the future. Moreover, expectations of similar help from the Fed may complicate private-sector solutions should another investment bank get into difficulty.

The Fed feared the consequences of a Bear bankruptcy because they believed that the stays that are central to the bankruptcy process would create systemic spillovers for Bear’s counterparties. They were especially worried about damage to other primary dealers that facilitate government borrowing.

The Fed lacked the resolution tools and supervisory authority that it (and the FDIC) would have with regard to a bank. These would have included prompt corrective action sanctions that might have encouraged Bear to find a private-sector solution before it faced bankruptcy and the authority to authorize a bridge bank that would have continued systemically important services and provided time for the regulatory authorities to find an optimal resolution for Bear Stearns. This episode revealed a huge gap in the U.S. safety net.

You could say that to the category of “too big to fail,” we have now added a category of “too interconnected to fail.”

Peter Capelli

George W. Taylor Professor of Management and Director of the Wharton Center for Human Resources

Wall Street traders earning half a million a year. Wal-Mart workers bringing home, on average, $19,100. Employees whose bosses have started demanding that they watch their weight in addition to their productivity. Cappelli has studied them all, offering his sharp observations on the state of American employment to the national media and to attendees at a recent leadership conference his center co-hosted.

Corporate America is paying attention. The leadership conference was listed among the top 10 most influential corporate conferences by corporate communications and marketing executives at Fortune 500 companies. Other conferences listed on the “Most Valued Podiums” study of 2008 include the World Economic Forum at Davos, Switzerland, and the Consumer Electronics Show.

Q. It seems like a lot of people are worried about losing their jobs, or are looking for work. How do today’s unemployment rates compare to historical averages? To periods of recession?

A. Compared to previous recessions from the 1970s on, unemployment is pretty low right now. The 2001 recession was one of the mildest in history, and this one is shaping up to be mild as well.

Q. Some presidential candidates are promising to stop American jobs from going overseas. How many jobs have migrated to other countries, say, in the last decade? Is it a major source of job loss? If so, can policymakers do anything about it?

A. It’s impossible to say how many jobs have gone abroad. A lot of jobs have been created in other countries by U.S. companies because that is where their growing markets are. The total number of jobs that have been “offshored” — sent overseas simply because labor costs are lower there — seems quite modest. Estimates are in the hundreds of thousands, not millions. But the number of jobs that have gone abroad because U.S. employers have lost market share to foreign competitors is huge.

Q. You’ve written that some companies resort to job cuts in sort of a knee-jerk way, thinking only of short-term savings and not of strategy. Do you see any evidence that this is getting better or worse?

A. There is no evidence that it is getting better. What we have seen before is that one big player cuts jobs and then the pressure is on their competitors to cut as well, primarily pressure from industry analysts and the investment community. We’ll soon see if this happens again.

Q. You also have criticized Circuit City for dismissing workers and then letting them reapply for the same jobs at lower pay. Are any other companies doing things like this? What could Circuit City have done differently, given that it was under intense pressure to cut costs?

A. I haven’t seen anyone else do this. It’s hard to know all the other options that were available to them, but the fact that no one else is doing this certainly suggests it wasn’t the only option. They aren’t the only company under pressure to cut costs.

Q. What employees/managers/executives are perceived as indispensable today?

A. Lots of people can be indispensable in the short run, because most organizations now run so lean that there is no backup and no real plan for succession. Anyone doing a job that is reasonably specific to the organization is indispensable. But, no one has long-term job security, because so many variables can change that make current strategies and current competencies obsolete — a change in what competitors are doing, a new opportunity to outsource work, an alternative technology. Then the indispensable is no longer needed.

Q. What traits are valued, versus what was valued a decade or two decades ago?

A. The big one is the ability to market oneself, to stand out in a crowd of competitors, to network. These are useful because they help individuals change employers.

Q. Is there anything employees can do — acquire specific new skills, for example — to recession-proof themselves?

A. Nothing is fool-proof in this area, except possibly being related to the owners. Short of that, it helps to be playing an important role that is close to the “core” or central competency of the organization. Most everything else can be outsourced. If you’re doing something reasonably hard to replicate and it is directed at some products or missions that it will be hard for the company to abandon, then you’re probably safe.

For more from Cappelli, check out one of his books, which include: Talent on Demand: Managing Talent in an Age of Uncertainty and Employment Relationships: New Models of White Collar Work.

Stephen J. Hoch

Patty and Jay H. Baker Professor of Marketing and Director of the Jay H. Baker Retailing Initiative

You’re not the only one shopping at Costco. Hoch shops there, too; only for him, such trips are part work and part good excuse to stock up on paper towels. He’s a shopping shaman, a master of the mall.

In his research, he’s helped explain, for example, why men and women should never go to the mall together if they want their marriages to work. That’s a hyperbolic version of one of his recent conclusions — that women like to shop, to linger in the aisles, to browse, while men want to buy quickly and leave. Here, he explains why more consumers lately are avoiding the store in the first place.

Q. Your research focuses on retailers. How have they been doing lately?

A. Up until six months ago, or maximum a year ago, retail has been pretty darn strong. It came out really strong earlier in the 2000s, and some retailers obviously did better than others. The luxury segment, the higher-end segment seemed to be quite robust even when things started to cool off a little bit.

Retail is a growth game, so people expanded retail capacity. They opened a lot of stores. I think what’s happening now is that retail has to hunker down and wait out the malaise that has hit the economy.

Gas prices have been high and food prices have been going up. Neither of those is in the core inflation measure, but people do have to spend money on them, so they spend less on other items.

As a result, we’ve seen a shift down in terms of quality. Just before Christmas, even high-end retailers that had seemed immune started to show strain. Neiman Marcus, Nordstrom, and other higher-end luxury stores had been benefiting, in part, from people jumping on planes to take advantage of the cheap dollar, but they just couldn’t sustain it.

So consumer prices are not reflecting reality. People are saying, “You know what, I bought a lot of clothes over the last five years. I don’t really need more right now.”

Q. Because of uncertainty in the housing market, some experts say any downturn could be much worse than those in recent memory. Do you think this is a normal cyclical downturn or something worse?

A. It’s a normal cycle.

Q. How do housing troubles tie into it?

A. I used to think of housing as an investment until I realized that it’s just consumption in a different form. People are so leveraged that I think it causes liquidity issues on the margin for everybody. It takes a long time for housing to get out of control, but it also takes a lot longer for it to unwind.

There’s a psychological factor, too. The value of someone’s house and the fact that they’re under water is a lot more salient to them than a decline in the value of their 401(k). They have to come home to it every day. You don’t sleep in your 401(k).

Q. What is the outlook for retail in 2008 and 2009?

A. At first, I thought it might last for six months, but now it seems it might go on longer than that. All you have to do is walk outside and say, “Do you think there’s enough retail?” to see the excess.

And part of this is a social thing. If everybody is talking about it, you think, “Well, gee, maybe on the margin, I ought to cut back.”

Q. In some ways, this economy feels like the 1970s — oil prices are rising, and people are paying more for food. From past experience, what do we know about how people’s habits change when staples take up a larger portion of the budget?

A. In terms of the consumer, we’re seeing a respite. It’s time to take a deep breath, and figure out, “Do I really need that extra thing, or can I make do?” But food is still incredibly cheap in the United States, compared to Europe. We’re still seeing McDonald’s and others offer 99-cent menus.

I remember in 1979, I had a 12 3/4 rate mortgage. This is not to say things are just rosy now, but I think there’s obviously resilience to the economy now compared to then.

Even so, consumers aren’t going to spend us out of this slowdown. When I saw lower-end retailers serving people who don’t have any kind of liquidity constraint, I realized, hmm, we’re there. That consumer malaise had hit us. Really rich people are shopping at Costco. Warehouse clubs have put up bigger numbers than I think people probably thought they’d see.

Miriam Hill is the Philadelphia Inquirer’s banking and personal finance reporter.

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