Cover Story

The New Abnormal


In March, Ralph Ronzio went to a warehouse in a seedy part of Orange County, Calif., and watched a guy auction off his condo for half what he'd paid for it. Ronzio had bought the place for $329,000 in 2005, when he moved to Southern California from Rhode Island to take a job at a data-storage company. It was the first place he'd ever owned. "It was totally my bachelor pad," he says. "Not much inside other than the usual leather couch and the big screen TV. My fiancée made me sell the couch."

That wasn't the only thing that changed when Ronzio got engaged. His fiancée had two young children, and there wasn't enough room in the condo for all four of them. So last year, Ronzio bought a house nine miles away and they all moved in. He figured he could rent the condo and cover his costs. He figured wrong.

The more he thought about the money he was losing, the more it stressed him out. Finally, Ronzio enlisted the help of a firm called You Walk Away and did exactly that from the remaining $319,000 on his condo mortgage. When the bank foreclosed, he says he felt an enormous sense of relief. He also had more cash. He and his fiancée took the kids to Disneyland. Ronzio, 31, gave himself a treat as well. "I bought myself an iPad," he says.

It used to be that someone like Ralph Ronzio could be fairly certain of the outcome when spending a few hundred thousand dollars on real estate. Housing prices were headed in only one direction. You could surf the boom and borrow against your home equity to pay for all manner of splurges—a vacation, a flat-screen TV, the latest Apple gadget. It may have looked like a lot of debt on paper, but considering that housing prices nearly doubled from 1999 to 2006, there was always an escape hatch: Sell your house and make enough money to pay it all back.

That was the old normal. Last year, Mohamed El-Erian, CEO of PIMCO, the influential bond shop, declared a "new normal," a global realignment in which the U.S. consumer, no longer a hungry monster, became cautious and subdued.

The current circumstances might be better described as the new abnormal, in which no one knows anything. In June the Conference Board Consumer Confidence Index fell 9 points on the heels of an 11 percent drop in the S&P 500 the month before. New housing starts were as bad as they had been in eight months. Meanwhile, the unemployment rate still hovers near double digits. That's 14.6 million Americans out of work. Federal Reserve Chairman Ben Bernanke only added to the anxiety with a July 21 declaration that the economic outlook is "unusually uncertain."

So who are all those people at the mall? It's easy to forget that a 9.5 percent unemployment rate means that roughly 9 out of 10 Americans in the workforce are still employed. "Some consumers are probably liquidity-constrained," says Kenneth Rogoff, Harvard University professor and former chief economist at the International Monetary Fund. These are "the ones who are probably not the ones buying iPads. But 90 percent of Americans do have a job, and maybe 70 percent are confident about them. And maybe half of those have liquidity."

On a recent afternoon, Lucy Johnston, 37, an accountant from Tulsa, Okla., could be found at the Fashion Show mall on the Strip in Las Vegas. She's cutting back on shopping and eating out because of the recession. "It's really tough right now," Johnston says. "I don't do many full-on spa days anymore." Yet there she was, shopping and vacationing in Vegas with her husband. "We've pulled out all the stops. We're staying at the Bellagio."

The new abnormal has given rise to a nation of schizophrenic consumers. They splurge on high-end discretionary items and cut back on brand-name toothpaste and shampoo. Companies like Apple, whose net income jumped 94 percent in its last quarter, and Starbucks, which is enjoying a 61 percent increase in operating income over the same time frame, are thriving. Mercedes-Benz is having a record sales year; deliveries of new vehicles in the U.S. rose 25 percent in the first six months of 2010. Lexus and BMW were also up. Though luxury-goods manufacturers like Hermýs and Burberry are looking primarily to Asia for growth, their recent earnings reports suggest stabilization and even modest improvement in the U.S. "Last September, retail started to recover on a very narrow basis," says Michael Niemira, chief economist for the International Council of Shopping Centers. "Most of the industry was really weak. It wasn't until the end of the year that you saw any momentum. It was all dollar stores and luxury. You have this bifurcated market. This year, it started to move to the middle a little. Now it's kind of moved back to the edges."

Of course, some of this is a reminder that the rich have been largely shielded from the recession's ravages. "All of my customers think we are out of the recession," says Marika Baca, an associate in the women's department at Barneys New York. "This time last year, it was bad. But now the women who were reluctantly picking up one piece are easily buying three." Aspirational middle-class consumers say they are also yearning to get their hands on the same high-end merchandise, just as they did in better times.

In such an environment, optimism about the economic future ebbs and flows constantly, with far-reaching consequences for a nation in which consumer spending accounts for 70 percent of the gross national product. It's an economy that defies smooth trend lines and suggests an EKG-shaped recovery—a sequence of mini booms and busts as consumer fads and pent-up demand drive sales, until the impulses fade. Erratic behavior is everywhere, even at Family Dollar Stores. "My feeling is that you can see week-to-week differences today that are far more volatile than what we have been seeing," said R. James Kelly, the company's president and chief operating officer, reporting a quarter with a 19 percent increase in net income.

The financial press, you may have noticed, is obsessed with consumer confidence. The collective hope is that at some point it will start trending steadily upward, signaling that the recession is finally over. And that's exactly what seemed to be happening earlier this year. The stock market had rebounded. Consumer confidence was on the upswing. It looked like the economy took on aspects of normal behavior—and then it all fell apart. In June the stock market gave back 4 percent of its value. And like teenagers suffering mood swings, consumers lost their nerve all over again.

On July 27 the Conference Board reported that confidence was at a five-month low, which it blamed on job insecurity. Lynn Franco, director of the board's consumer research center, served up an appropriately grim metaphor in a statement: "Concerns about the labor market are casting a dark cloud over consumers that is not likely to lift until the job market improves."

Not everybody's consumer diagnosis is the same, though. Shortly before the Conference Board released its finding, Consumer Reports, the venerable 74-year-old magazine, unveiled the results of its monthly telephone survey about economic issues. It found that consumers had ramped up their retail spending by an average of $40. Though major purchases like cars remained unlikely (Mercedes drivers must be hard to reach in phone surveys), Americans were planning to spend more on appliances and electronics.

Ed Farrell, a director of the Consumer Reports National Research Center, says: "We just focus on what's happening this month. We don't ask people want they think the business climate is going to be like in a year. If these people could tell us that, we'd all be very well off."

American Express released the results of its consumer survey on July 13, showing more willingness to spend, dampened somewhat by guilt and despair on the part of some of these same respondents. The credit-card company found that 51 percent of consumers had fallen behind on their annual savings plan, in part because they were either making impulse purchases or simply spending beyond their means. There it is: gloom, muted optimism, and wild abandon.

Yet what if these things aren't exclusive in the new abnormal? Frank Veneroso, an investment strategy adviser in Portsmouth, N.H., closely follows the nation's saving rate. It was his opinion that high debt levels and economic fears would force Americans to rein in their spending and increase their savings. In the early part of the recession, that's precisely what happened. Then it stopped happening. Veneroso theorizes that the nation's wealthier citizens were so relieved when the stock market rallied last year after the financial crisis that they went on a "celebratory spending spree." He believes that recent market turmoil will put a stop to those good vibes and that savings will start to inch back up.

Except market rallies are not the only thing that emboldens consumers. Market dips can also loosen up purse strings, says Dan Ariely, a professor of behavioral economics at Duke University and author of Predictably Irrational: The Hidden Forces that Shape Our Decisions. When people get freaked out by market gyrations, Ariely says, they see the advantage of shopping over putting money into a mutual fund that might tank. "If they lose money by spending it on something," says Ariely, "at least they have something to show for it."

The point is that, for consumers looking for a reason, ups and downs can both provide a justification for spending. Stephanie Redmond, a 25-year-old electronics worker, talked about her financial woes as she shopped at the Dolphin Mall in Miami. She described herself as pessimistic about the economy. "I don't see it getting any better. I mean, I need a new car, but I don't plan on getting one anytime soon." Instead she recently bought a plane ticket to New York and stayed in a Times Square hotel. "It was my first time, so it was a lot of fun," she admits.

At the Woodfield Shopping Center in Schaumburg, Ill., Michelle Rodriguez, 39, a part-time cafeteria worker at a local high school, shared her litany of complaints. She said she cut back considerably after losing her old full-time job two years ago as a receptionist at Kraft. "I think the economy has a ways to go," she sighed. "I don't make nearly as much as I used to make." And yet she confessed to purchasing a 46-inch flat-screen Sony TV in the last year. And now she was waiting for help in the Genius Bar line at the Apple Store.

One way of understanding Apple's recent success—the company announced "all-time record" revenues of $15.7 billion for its quarter ending on June 26—is that the iPad is perfectly positioned as a compromise product for people who crave the kick of a new Apple gadget but don't want to spring for a Mac. "I was talking to someone recently who said to me, 'I bought the iPad because I can't afford a new iMac,'" says Carla Serrano, chief strategist for TBWA/Chiat/Day, Apple's advertising agency. "O.K., fine. But the iPad does hardly anything that an iMac can do." She believes that the recession is making people think they need to come up with what she describes as "post-rational" justifications for their extravagant purchases.

The performance of Starbucks suggests that everyday luxuries have also not been wiped out. On July 21 the coffee chain announced a "record" quarter with same-store sales growth of 9 percent—the biggest increase since the second quarter of 2006, the peak of the old normal. CEO Howard Schultz boasted of Starbucks' new products, like its "customizable Frappuccino campaign," as well as Via, its new instant coffee, which is pitched as a budget item, though not exactly priced like one when compared with other instant competitors. (A 12-packet box of Via goes for $9.95.) Starbucks is the lower-end corollary to Apple, a purveyor of expensive treats. Stephanie Redmond, the Miami electronics worker, may not buy the new car she needs, but give up Starbucks? Never. She has to have it "every day!"

Mass marketers have a tougher time seducing consumers with psychological value. Burt Flickinger, a retail consultant based in New York, says Procter & Gamble is struggling to keep people from abandoning its Ivory soap and Crest toothpaste for generic brands. The irony is that it is often the same people juggling iPhones and venti lattes who are open to switching to off-brand laundry detergents. According to Flickinger, better-educated shoppers understand how little difference there is in quality on many household items.

They may also be sneaking into discount retailers for these deals. "The dollar store is the new Target," says Al Moffatt, CEO of Worldwide Partners, a Denver-based advertising company. "You go in there to buy shampoo for a buck so you can go to Starbucks and justify spending $3 for a coffee." Moffatt admits that he and his wife recently did their own variation on this recessionary theme. On a trip to Oregon, they bought cheap towels at a discount store before hitting a pricey spa.

Ran Kivetz, a professor of marketing at Columbia Business School, has done extensive research on consumer psychology. He argues that consumers' brains lack a line that separates spending from saving. Instead we practice a certain amount of thrift so that we can justify blowing a large sum frivolously.

Kivetz says the recent downturn has made consumer thinking even more conflicted. In the short run we feel good when we save. In the long run we tend to regret the denial of a spending outlet. "We feel guilty" about spending, Kivetz says, which can lead to more irrational purchasing.

And that, says Kivetz, is exactly what's happening now. Consumers were quick to reduce spending when the recession arrived. Then the recession lasted longer than expected, and the new abnormal set in. The economy started to improve. Then it appeared to worsen. Kivetz says there is only so long we can suppress our need to spend. "It's just been a slow walk out of the woods," he sighs, "and it's so complicated. The things going on in Europe are frightening. There are problems with China, with our government debt, and bank debt. At the end of the day, people are saying, 'There is still risk. I gotta cut back.' But this is not a typical one-year recession. Life has to have some normalcy. I have to have some luxuries."

There was little evidence of the recession at a recent lunchtime in the Mall of America in Bloomington, Minn. The nation's largest mall was full of shoppers drinking expensive coffee and toting bags of electronics and expensive shoes. Some of them were there on vacation. Why not? The Mall of America doesn't just have 520-plus shops, it has an enormous amusement park and a 1.2 million gallon aquarium. The opportunities to splurge are almost overwhelming, and sales are up 9 percent so far this year.

Mellissa Williams, a 30-year-old teacher from Laredo, Mo., was looking for sneakers with her two children at a sporting goods store. "We'll be looking at price tags a little more than we normally would," she said. And yet she had come a long way to look for deals. What was her biggest splurge in the last six months? "Probably this trip," Williams said.

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Leonard is a staff writer for Bloomberg Businessweek in New York.

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