Spending

If you consider the US economy, it is 70% driven by consumer spending. The cars, appliances, apparel, computers and everything else people buy, is the primary component of our economy. Now this is impacted by all sorts of things, but two main components would be:

a. Willingness to spend - consumer confidence
b. Amount available to spend - total money and credit

Now these are not totally independent, everyone feels less confident about spending money when they either really have or think they have less to spend, but certainly, when you haven't had any change in your actual ability to spend, you will spend less if you think you may be adversely impacted in the future.

However, the amount available to spend has an upper absolute. If you actually have no money and no credit, you can't spend even if you want to. Many people looked at their homes as a sort of savings account where they could finance major purchases using the equity they had stored there. We had a drastic reduction in that equity with the reduction in home valuations. Further because the banks and financial institutions had to write down the valuation of these assets, they had less money to lend.

Everyone talks about the people who lost their homes via foreclosure. However, in many cases, while the foreclosed houses place a drain on financial institutions, once you have lost you home, assuming you have an income source, you actually have more available money to spend, since you are no longer paying off the mortgage. Now unemployment may have also impacted some of these folks so nothing is ever a clear one to one correlation, but it would be interesting to see a study of disposable income of this group before and after being foreclosed on. I think spending may actually go up (except of course the mortgage payment part).

However, those who didn't lose their homes were faced with a reduction in what was effectively their emergency fund. If you had been saying to yourself, well I can tap the equity to pay for college, or I can tap the equity for retirement, or whatever, when the equity disappeared you realized you had a problem. So they had to stop spending because, well, the money was gone. Also, they started to realize that the house as a source of ready money might be a problem.

So savings is up and spending is down. This is bad for the immediate economy, however, it might be very good for the future economy.