Same Solutions, Different Problems

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.

Comments

[cjop]

Thank you for the very informative posts. I think you are right on the money. My state, South Dakota, has no usury laws to speak of and our representatives in Washington have insured their friends at Citibank and First Premier that their predatory lending practices will continue unabated. They also felt that it was important that the bankruptcy laws be changed to protect these institutions. First Premier in particular has made millions going after people who can ill afford the credit. All under the guise of helping people reestablish their credit. I think you were also on the money with an earlier post regarding the complete lack of over site the last 7 years. I wish I could blame president Bush but the Democrats seem unwilling to challenge this administration. Washington truly is the problem.

[Allan]

Does the Fed lowering interest rates mean that credit card companies will also? If so, please tell my credit card companies, which, to my knowledge, have only raised rates.

And it does not make much different for bank accounts. Interest is so low now, that the only possible result would be for me to pay the bank for letting me have money in their institution. Wait... I already do that.

Lower interest rates are beneficial for long-term mortgages and businesses.

[JJ1]

These statistics on the debt load are alarming. If debt loads continue at this pace, this could be the straw that breaks the camel’s back. What is the long term plan? The stimulus plan may provide a short term solution to the economic problems facing our country; however it does not address the root cause of the underlying financial problems encompassing more and more consumers. At best it is a band aid approach. Band-aids can only provide temporary solutions to ailing problems and if the growing debt load continues to weigh down consumers, helping the economy recover will be more costly further down the line. It would be beneficial if the administration would come up with economic solutions that could provide a long term vs. short term impact. Alas, it is not likely in the current administration. Reigning in abusive lending practices would help address the source of the problem and the long term benefits of helping folks emerge from debt would have a much greater net effect then the proposed stimulus plan.

If lenders were required to reign in abusive practices, more consumers could have a chance to recover from the mountains of debt weighing them down. I’d start by making some changes to the (TILA), making lending terms more transparent and applicable to the host of financial products that have appeared in the marketplace over the last twenty years. Credit cards should not be able to state they reserve the right to ‘change the terms at any time’ since this supersedes all other language in the contract. The way some of the lending practices have run amok and with the recent housing crisis - we’ve seen that markets may not necessarily correct themselves and have required multiple interventions. If we are able to reign in some of these abusive practices in regards to fees and other destructive lending practices, consumers may begin to feel a renewed sense of economic security. Restored economic security can bring about greater economic opportunity.

[AL]

I really believe that alot of this debt is due to medical and increased food and energy costs. Also many are forced to finance their education on credit cards. I see people using their credit cards to purchase needed medications because they don't know how else to afford them.

I see a big problem that many of these banks like Bank of America and Citigroup are raising their credit card interest rates on customers with existing balances - in order to offset their huge losses from mortgage investments. That should be criminal that other consumers have to pay for their CEO bonuses and poor management decisions.

[Howard Liker]

We may be able to use mediation services between the consumer and the banks. These services are already paid for by the taxpayer and are located in counties throughout the nation. Ask your local mediation services to help the parties mediate issues regarding credit cards and mortgages. Both the consumer and the bank will benefit when the sit face to face regarding financial debt. I am the chairperson of the Insttute For Medation and Conflict Resolution

[Howard Liker]

the credit card compnies have not passed on the rate reductions to their consumers. It is amazing that the government reduces the banks' rates but they only increase the consumers' rates for any reason possible. When will this cchange?

[Dale]

If, perhaps, we went back to the style of living that existed when I was a child in the 1950's, then perhaps we might slowly work our way into a new and simpler way of living. Closets were smaller because we did not have as many possessions, nor did we feel the need to have more. Appliances and other necessities were built to last, and to be fixed if necessary, as people did not feel the need to throw away good items. Yes, this was prior to the transistor, but that simple principle could stay apply to this date: we always tried to re-use and recycle what we could. As our population grows older, money can still be made by servicing our people's needs, enjoying dining, movies, games, etc. These are all ways that people can still earn money and live comfortably. For the medically uninsured, instead of charging them a full rate, which no insurance company pays, give them a payment discount if they can pay within 10 days. This economy needs to re-learn the art of patience so that companies can focus on future returns and incomes and not stay so short sighted. Such short sightedness brings with it many of the problems of these times. When a person's credit history is not stellar, they are charged a higher interest rate when buying a car or home. This, of course, makes it more likely that they will not succeed in keeping payments current. How about finding new ways to help the more challeged consumer without setting them up for failure? I, being a product of my time, still have hope that simpler solutions can be found.