The Rise of the Zombie Consumers

They’re in debt, they’re depressed, and they’re everywhere


They're not exactly roaming through malls, arms aimlessly extended and bloody bandages dragging through stacks of sweaters. But "zombie consumers" are haunting the economy whether they're visible or not.

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Economic zombies are different from the kind in bad movies. Instead of lumbering around creating mayhem, they drag down the economy passively by tying up capital that could be put to better uses. The most notorious zombie economy was Japan's in the 1990s, which economists are now diligently studying as they look for parallels with America today. After a painful real estate bust in the late '80s, Japan endured a decade of stagnation, deflation, and falling living standards. Zombie banks, with government complicity, made the problem worse by refusing to acknowledge losses and write them off. By prolonging the inevitable and holding large reserves against bad loans, the banks took vital capital out of the Japanese economy for years.

The U.S. government has been more aggressive toward its own banks, injecting capital into them during the financial crisis, conducting stress tests to evaluate their health, and shutting down insolvent banks at a healthy clip. But it's been harder to deal with homeowners who are underwater on their mortgages or defaulting outright. And that may now be escalating into a bigger problem that Washington failed to anticipate. As we're learning, the economy can't move forward if too many consumers are saddled with debt, especially if it's debt they're likely to default on in the future. "It's like running through knee-deep water instead of running on dry ground," says Alan Levenson, chief economist at investing firm T. Rowe Price.

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Washington has tried to stimulate housing by driving mortgage rates down, stabilizing the financial sector, offering home-buyer subsidies, and backing the vast majority of new mortgages through the nationalized mortgage agencies Fannie Mae and Freddie Mac. Yet the housing market is still terrible, with the pace of sales at 1995 levels and prices dropping for the fourth year in a row. Programs meant to directly help the most troubled homeowner are largely ineffective, in many cases simply delaying foreclosures instead of preventing them. The nation's housing woes are so pernicious they could even choke off a weak recovery and trigger a double-dip recession.

The disastrous housing market is also turning millions of once-proud homeowners into handcuffed consumers unable to spend if they want to. First are those who have already defaulted. Since 2007, the year the recession began, banks have foreclosed on more than 8 million U.S. homes, according to RealtyTrac. Some of those defrocked homeowners now have cash to spare, since they've been freed from onerous mortgages. But most of those people are impaired consumers with wrecked credit and, in many cases, preexisting financial problems that led to foreclosure in the first place. They're not spending the way they did five years ago, to say the least.

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Payments on another 4.4 million mortgages are overdue, according to the Mortgage Bankers Association, with borrowers struggling every month to come up with the cash to stay in their homes. Some of those will end up as foreclosures. Other borrowers will catch up on their payments. And some of the overdue mortgage holders will muddle along in a continual state of arrears, not completely in default but not solvent either. This is partly a result of Washington's mortgage modification programs, which try to lower borrowers' monthly payments through reduced interest rates or longer loan terms. But those programs don't typically reduce the principal, which means either the bank or the homeowner stands to lose on the home—eventually. And putting off the moment of reckoning is similar to one of the problems Japan had. "When you don't realize the loss, the healing process is in a state of suspended animation," Levenson says.

Another 13 million or so homes are owned by people who owe more than their home is worth, according to Many of these "underwater" homeowners still have jobs and are able to make their monthly payments, and they'll never default. But they've endured a sharp loss of home equity and their net worth might even be negative—making them net debtors—since for many people, their home is their biggest asset. Those people may still have good credit, but banks are unlikely to lend to them. And their own sense of well-being is deeply degraded, which limits what they spend. They may even feel like zombies, stunned and depressed by their reduced prospects.

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My math is imprecise and there may be some overlap among categories, but adding up foreclosures, overdue mortgages, and underwater mortgages suggests that roughly 25 million households are in some state of financial distress, due simply to the housing bust. That doesn't count renters or people living in someone else's home, who have their own share of problems. If you make an oversimplified (and conservative) assumption that there's one overwrought American per distressed household, that's 25 million zombie consumers—about one-tenth of the adult population.

Those zombies aren't economic zeroes, either. Since they're all current or former homeowners, they're wealthier than average, so typically they would spend more. Some of them are small-business owners, who tend to use their homes or personal assets as collateral when applying for a loan to expand their business. So lost home equity is probably one reason small-business lending is moribund—and small businesses aren't hiring or expanding. The loss of home equity also has a direct impact on car purchases and other big-ticket goods that are down sharply. And many underemployed people who might move to where jobs are more plentiful—which usually happens as economic imbalances work themselves out—simply can't, since they'd have to take a prohibitive loss on their homes if they sold.

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Consumers in general are doing what they ought to be doing to dig out of a hole—saving more money and paying off debt. That's prudent, but it also means less spending today, which in turn means less business for companies and fewer reasons to hire. In Washington, meanwhile, policymakers waiting for a recovery to gain strength are struggling to understand the economy's latest ominous plot twist. The good news is that unlike the villains in a horror flick, most zombie consumers are likely to snap out of it some day and come back to life. But this movie could run on a lot longer than most viewers desire.