Bankruptcy

Same Solutions, Different Problems

By Elizabeth Warren

Economists teach that if the economy is going into a recession, lower interest rates and give people money. That wisdom is so conventional that the only quibbling seems to be over timing, amount, and who gets the money.

But this recession has one very special feature:  Never in history have we hit a recession with the American consumer so loaded down with debt. Shouldn't that cause someone to pause before concluding that more consumer spending is the way out of this hole?

The American consumer is financially exhausted.  Debt loads now exceed annual income.  The proportion of income that goes to interest payments is at record-breaking highs. Twenty-three million families cannot make more than the minimum payments on their credit cards.  One in four families say they are worried about how they will pay their credit card bills this month.  Nearly half of all credit card holders missed at least one payment last year,  and an additional 2.1 million families missed one or more mortgage payments. (Data cited here, here and here.)

The federal government can borrow money to give to families.  If families are smart, they will use the money to pay off some debt. But even if they make new purchases, what are the prospects for long term recovery?

The problem is that Americans owe a lot of money.  They owe so much money that they can't pay it off without substantially reducing future spending.  And if they reduce future spending, they can't keep the economy going.

Think of it this way:  The average American family that carries credit card debt owes about two months' income on their cards.  Wages are essentially flat, and both mom and dad are already in the workforce.  That means that some time in the future they can repay this debt only if they spend less than they are spending today--a lot less.  What happens when they cut back on spending?

There's another implication to this huge debt load:  interest.  Interest operates just like a tax--it has to be paid month after month, in good times and in bad.  Unlike a tax, however, interest isn't calculated on something good like income; it is calculated on debt loads.  For the average family carrying credit card debt, interest payments alone have become a more significant household expenditure. 

In 2006, credit card companies collected about $90 billion from American families in interest, fees, late fees, penalties and the like.  That's $90 billion that didn't go to buying socks or movie tickets or Big Macs.  The American consumer can't keep it up.

Maybe the economic stimulus will work for a while, and maybe it won't.  But I'm sure that a real, long-term solution to the problems facing the American consumer and the economy will take something very different.  A good starting point is to take a hard look at reining in abusive lender practices.  Notwithstanding what JJ says, families will have a hard time getting back on their feet financially if they are trying to fight off lenders who are selling them credit products loaded with tricks and traps.

Full post as published by Credit Slips on January 27, 2008 (boomark / email).