Prime Angst: The Ricochet Effect

We’ve been reading woeful articles about the subprime mortgage mess for more than a year now, but it was just the prelude to a much larger global disaster. As New Yorker columnist James Surowiecki put it in April, “The subprime crisis was an earthquake that caused a tsunami: The quake has done plenty of damage on its own, but the tsunami looks set to do even more.”

The U.S. is already in the throes not just of the subprime crisis but a related, and scarier, “prime crisis,” in which borrowers with good credit and traditional, 30-year fixed-rate mortgages — and even people who own their homes outright — are also feeling the pinch.

The crisis started when lending institutions began taking risks predicated on the belief that housing prices would continue rising. They made loans at higher-than-standard rates — often with enticingly low “teaser” rates that jumped up after a couple of years — to people with poor credit, then bundled these loans into mortgage-backed securities, which they sold to investment banks. Banks packaged them with higher-rated bonds into collateralized debt obligations (CDOs) and sold them to hedge funds, which borrowed money using the CDOs as collateral.

This created above-average profits for everyone as long as housing prices rose. But when subprime borrowers started defaulting on their loans, prices fell. So did the value of CDOs, and lending institutions started calling in their loans. Capital valuations plummeted. The ramifications for Main Street consumers are now a familiar litany: layoffs, bankruptcies, foreclosures. Nearly 3 million U.S. homeowners (6 percent) were behind on their payments in the fourth quarter of 2008, and more than a million more (a record 2 percent of loans) were in foreclosure. And don’t think the worst is over: “We don’t expect to see a peak in delinquency rates and foreclosures until mid to late 2008,” Doug Duncan, the chief economist of the Mortgage Bankers Association, told USA Today in March.

I myself am a victim of the mortgage meltdown. My home has lost roughly 20 percent of its value since I purchased it 24 months ago, putting down 10 percent, which means I have negative equity in a house that now feels like a barn/big black hole (it’s both!). A few weeks ago I sat around a suburban dining room table with other fortysomethings, who spoke of deciding their children would take a “year off” from college because their home equity line (nonexistent or much reduced) couldn’t cover tuition. My unscientific poll of nine adults, ages 37 to 61, found that we were all planning on less apparel, limited summer air travel and “luxury only for milestones and rituals.” Even though we can still cobble together money for some indulgences, our prime angst means we’re battening down the hatches and saving.

We aren’t alone. Consumer confidence is plummeting. In April, the U.S. Commerce Department announced that consumer spending advanced by only 1 percent annualized in the first quarter of 2008, the weakest performance since 2001. Spending fell for cars, auto parts, furniture, food and recreation, a trend that will likely continue as costs soar. Add the dollar’s historic lows against the euro, British pound and the Canadian dollar, and the outlook is especially grim for travel and vacation spending.

Sobering as this is for consumers, it’s even more alarming to companies. A few industries may see sales increase. Farmers and producers of local goods could benefit as consumers shop closer to home. This is not a bad time to be selling low-cost, travel-free forms of entertainment.

But most marketers will have to be cannier to compete for an ever-shrinking piece of the spending pie. Which corporations and brands will be smart enough to thrive when consumers realize how much money they don’t have?

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