The Debt Threat
The Center for American Progress issued a grim report yesterday showing that household debt grew by a staggering 33% in just three years from 2001 to 2004. In 2001, debt stood at a shocking 78.1% of income. Today those numbers look small. In three years, debt reached a 108.4% of household income.
What’s our exit strategy? When—and how—does the debt get paid down? Think of it this way: If debt is 108.4% of household income, then the average family has spent more than a year’s worth of tomorrow’s earnings. Someday in the future, that average family is supposed to cut spending enough to make up for all the interest payments and principal due on this debt. How will that happen—and what will it mean for the economy?
The CAP report shows that the big debt run up wasn’t a spike in buying Gameboys or $200 sneakers. That’s bad news, because it means cutting back on frivolous spending isn’t going to solve this problem. The problems are more fundamental. Increases in the cost of housing bore down hard on families. McMansions may get all the attention, but the price of a basic 3-bedroom-1-bath where the median family lives also shot have through the roof in hot housing markets. Health insurance, child care and college costs have not been far behind. Once families are committed to big mortgages and they have high balances on their credit cards, interest payments start to take on a life of their own, draining money out of their budgets as relentlessly as utility payments and food. The payments leave them with even less money to cover expenses, and the downhill slide starts to gain momentum. In other words, the debt breeds debt, and the debt itself makes it less likely that a family can pay it off.
Incomes are flat. A fully employed male today earns, in inflation-adjusted dollars, slightly less than he earned in the 1970s. The only growth in household income for the middle class has come from putting mom to work—but that’s already happened and that income has been spent too. So where is the money coming from to pay down the debt?
Economists describe the health of the economy as dependent on consumer spending. But as more dollars are drained away for mortgage payments and interest on credit cards, where is the money to buy tomorrow’s cars and clothing? Household debt won't be a problem just for the families that are struggling; it will be a problem for every manufacturer and retailer in America.
The fundamentals are off. Income is flat. Costs for housing, health insurance, daycare and college are steadily growing. Families are quickly running out of maneuvering room. And, once again, there is no exit strategy is in sight.
Comments (48)
I searched the report with reasonable care and I couldn't discover whether or not home mortgages are included in the report's definition of "household debt."
If mortgages are included, the conclusions of the report seem a bit off-base: it's not unreasonable to assume people are taking on bigger mortgages as housing prices increase.
May 12, 2006 8:56 AM | Reply | Permalink
Yes, home mortgages, credit card debts, car loans and many other debts are included.
The data show that home values went up, but mortgage debt went up faster. This is the scary point: the home value may swing back down, but the homeowner will remain obligated to pay the entire debt, plus interest.
The real point is Americans are shouldering more debt just to buy a modest home and make it from paycheck to paycheck. The fact that they can now take on a quarter-million dollar mortgage to buy a 3-bedroom house in a not-very-fancy Boston suburb is NOT making them better off. A house is not an asset like stock. Unless the family plans to sell at the peak and move to a cave, they must pay housing costs--and that means bigger and bigger mortgages that will stay big even after the market collapses.
The fundamentals are off--flat income and higher expenses are putting the middle class on the ropes.
May 12, 2006 9:13 AM | Reply | Permalink
I had the same question and I think they are included. I was thinking that if someone was single, in her late 20's or 30's, had an income of 60K, savings of 50K, and her only debt was a mortgage of 90K, she wouldn't really be that bad off, even though her debt/income ratio would be 150%.
Also, they mention that whites now pay basically the same % of their income in debt payments as blacks and Hispanics. I've read that houses in largely white middle-class areas in at least some cities (Chicago being one) have had their values go up faster than houses in black middle class areas, which I'm guessing means they might have more housing debt. Also, I would think whites are more likely to go to more expensive colleges and to be less likely to get low/no interest financing, but that's a guess.
I think the report acknowledges that people have to take out bigger mortgages because of increasing home prices. But that makes it more likely you'll lose your house or get into trouble.
May 12, 2006 9:15 AM | Reply | Permalink
Mortgage is included.
My rough estimate is that 100% debt level is consistent with taking 30 year mortgage equal to 3 times you yearly income, paying it over 30 years and living for 15 years without mortgage debt. So it may be reasonable -- for those families that are average or better.
May 12, 2006 9:38 AM | Reply | Permalink
Rising costs of drugs -- in spite of Plan D -- and the need of many seniors to either forego medication or use plastic to pay for it. Ditto co-pays, deductibles. And when you're not a senior, when you're pre-Medicare, you're in even worse trouble if you're a low income person. Health insurance premiums are also out of control if you're self-employed, or a senior paying for "medigap."
Rising housing and therefore property tax costs. Many seniors in my area -- one of those "ten best" places to live so everyone is moving in, pushing the market up -- are in trouble with property taxes. One widow I know about continues to live in the small house she and her husband bought 40 years ago. Because it's in a town where houses -- even in modest neighborhoods -- are shooting up in value, way way up, she's going into debt to pay property taxes. Where else can she live? This is her house; these neighbors and old friends are her support system.
And let's not forget that for most people, the economy isn't good and inflation (gas prices pushing everything up) is omnipresent. Inflation which, of course, when they admit it's there, will push up borrowing costs.
I'd like to know more about what percentage of that debt is related to paying for necessities, what percentage to "wannas." To the extent that it's necessities, we need to put something in place to give people relief. To hell with fat-bellied conservatives and their "if I'm okay, you're okay" attitude.
PS. Noticed the ever-increasing totals on various lotteries? Think about who's contributing to the winner-take-all fantasy...
May 12, 2006 10:06 AM | Reply | Permalink
The May issue of "Harpers" paints a grim picture of what may face recent homebuyers. Titled "The New Road to Serfdom" it says that because home prices are falling while mortgages remain the same or increase, eventually resulting in a situation where home value is less than what recent homebuyers owe, they'll be trapped. They can't sell, the declining market won't cover what they owe the bank, but they still have to make those (often growing) monthly payments. They will have to cut back spending in other areas or lose the house, and everything they paid for it, in foreclosure. (Of course they could sit tight and wait for a rebound in the market.)
May 12, 2006 10:32 AM | Reply | Permalink
Elizabeth,
I too see this as a very troubling trend. Maybe the biggest problem is that it is a TREND that is getting worse at an alarming rate. In other words it is unlikely to stop at 108%. People are refiniancing their houses and racking up their credit cards, but their wages are not going up. So they will get new credit cards and refinance their houses again to pay off the old credit cards and mortgages. When they are late on credit card payments, interest rates will go up and make them even harder to pay back.
People are getting credit that they probably should not have access to and it is all going to get very ugly here in the next five years. Add this to the Bankruptcy bill and it's a real recipe for disaster with average people slaving their whole lives to pay off debts incurred during the Bush years.
The credit card and mortgage companies are now pretty much guaranteed to get paid back over time so there is very little incentive for them to be selective about to whom they give credit.
Its very much like the way that Bush is handling the economy in general. Cutting taxes and increasing spending and putting it all on credit. It's unsustainable and is going to lead to a huge trainwreck.
May 12, 2006 11:10 AM | Reply | Permalink
One widow I know [is] going into debt to pay property taxes.
Debt which will be repaid at the time of her death by the sale of the house -- a reasonable employment of the savings (home equity) which she and her late husband accumulated over their working lives to see them through their retirement.
May 12, 2006 11:20 AM | Reply | Permalink
Back in the mid-to-late 80s, when oil prices dropped, you had a similar situation in major oil-producing regions -- Colorado, Texas, Louisiana...
It didn't lead so much to serfdom as to a disaster for lenders. With similar houses renting down the road for half of what a mortgage cost, homebuyers were thrilled to walk out and let the bank foreclose. They lost their equity (but in the days when some banks were offering 5% down, that wasn't such a big deal) but their lower bills may have been worth it.
I can imagine something similar happening in an economic downturn now, but on a broader scale. Or perhaps banks simply looking the other way as long as they can, because foreclosure wil put all those losses on their books.
May 12, 2006 11:43 AM | Reply | Permalink
Good point.
It reminds me of a story I saw on the news years ago about farmers in Colorado, I think. All of a sudden that area was hot property, pushing up the values of their farms, and making the taxes harder to pay. So, you're going along feeling sad for them because they are going to have to get a cheaper farm that their grandparents hadn't lived on back in the 1930's. There was talk of getting the government to reduce their taxes because they wanted to stay.
At the end of the story though, you hear that they can sell their farm for well over 1 million. I feel a little less sad at that point. Still sad because it's not what they want to do, but they're not going to be destitute. In cases like that, I don't think that the government should pay those individuals' taxes AND let them keep the value of their property (otherwise others will be subsidizing their wealth).
May 12, 2006 11:52 AM | Reply | Permalink
One of the things that is not being discussed much in the media (or anywhere else) is the effect of mortgage fraud and appraisal fraud is having on the market. I am not enough of an expert in the area to make a good judgment on the issue, but I have no doubt that it plays a part in inflating the prices in hot markets.
Find the Truth. Do Justice.
May 12, 2006 12:34 PM | Reply | Permalink
A problem with that is the bank or finance company can still file a lawsuit to recover any deficiency owed between the balance of the loan on the house and what it was sold for at auction (usually a fraction of its appraised value -- which is usually far less than the appraised value when the home was bought). Upon the deficiency judgment filed with the court, the creditor will them report that deficiency to the credit reporting agencies -- often preventing the debtor from obtaining new credit (house, car, credit card, utilities, insurance, etc). So, simply stated, surrendering the house is not usually a solution, either.
Find the Truth. Do Justice.
May 12, 2006 12:43 PM | Reply | Permalink
Yeah maybe a good compromise would be a tax deferral. Let the tax bill accumulate (with interest) and when you sell the house and/or farm you pay it back.
May 12, 2006 12:51 PM | Reply | Permalink
Well, it just means everyone's going to go bankrupt. As the Italians say, "mal comune mezzo gaudio".
Independent Illinois Grassroots: IllinoisDemNet.com
May 12, 2006 1:29 PM | Reply | Permalink
Debt has been rising for the government as well as personal debt. Both the national and balance of trade deficits keep rising. There have been various discussion about this, the most recent being politicians floating the idea of tariffs and/or currency adjustments.
Historically high federal debt has been "solved" by inflation. With taxes continually being cut this seems like the most likely outcome. If this is true then those with no capital will come out the best. People holding fixed yield assets like bonds are the big losers during periods of inflation.
So, we have transitioned from a society with a fair amount of savings (which for most people was in the form of bank accounts) to one in which people "rent" their possessions. Homes and cars require little down payments. In fact many cars are not even purchased anymore, but leased. So in an inflationary period the average household will not see the value of it's savings decline - it has none.
During the Carter/Nixon inflation workers came out about even. This was because there was enough of an organized labor movement to ensure that wages (almost) kept up with the increase in inflation. These days with an ineffective labor movement the prospects for wages tracking inflation are not as certain. Widespread misery may not be out of the question.
See my essay from last year, which still seems pretty accurate to me: The Coming Crash
--- Policies not Politics
Daily Landscape
May 12, 2006 1:59 PM | Reply | Permalink
Re: A problem with that is the bank or finance company can still file a lawsuit to recover any deficiency owed between the balance of the loan on the house and what it was sold for at auction
However they won't do that normally because that will cost money with uncertain chances of recovery, and meanewhile they have a more certain route to recovery of losses. Unless the mortgagee has over 20% down (in which case he's unlikely to be eager to default) his mortage is covered by PMI (for which is paying a bundle in his payments)
and that allows the mortgage holder at least to recover any moneys lost if the mortgagee defaults.
May 12, 2006 2:35 PM | Reply | Permalink
Home equity is savings? Seems to me it is a figment of our imaginations until there is a buyer that turns that equity into cold hard cash. Last I knew a savings account had cash in it. A slow real estate market can wipe out equity. It is foolish to think of your house as an investment unless you plan to "move to a cave" when you sell it, as Elizabeth Warren says in her post.
Carrying a loan like this is fine if it is interest free, because the collateral will pay it off, but that doesn't happen. When you pay interest, the bank is simply siphoning off your weatlh for nothing in return. It is taking it out of the economy and putting it back into the banking system where the money is created. The value of the labor that earned it is lost. This is not just a redemption of Federal Reserve Notes, it the fruit of their labor. (barring enough growth in equity at the sale to compensate for the compounded interest - but that is speculation.)
Jim Anderson
The Truth About Credit
May 12, 2006 5:51 PM | Reply | Permalink
Considering the leadership and course of the country over the last 6 years, 'considerable misery' seems not only inevitable, but well deserved.
May 12, 2006 6:02 PM | Reply | Permalink
What we are watching are the beginnings of the decline of the United States economy. Incomes are flat. Expenses are not. People need more and more of their income to pay for basics. They are borrowing more than they can afford. They are not building up equity in their homes. Their debt is increasing.
Yesterday I analyized the finances of a young 30 year old man with a solid union job. He didn't have outrageous credit card debt. Instead he has a 1st, a 2nd, a car loan, a loan for tools and one small unsecured loan. There is simply no way for him to pay his secured debt and provide for his young family. He has two children at home. His significant other doesn't have the skills necessary to contribute much to family income. Think minimum wage. He is not a candidate for a bankruptcy. He would still have to pay the first, second, the car and tool loans. His only solutions are a better paying job or a second job. He is a fully employed union member. He has an associates degree and is a fully qualified technician in his field. In our community it is unlikely he is going to find a "better paying" job given his skill set. Anyway he remains in his job because of his union benefits. His children really need health insurance. At this point he is probably going to have to work 60-70 hours a week just to keep bread on his family's table. Something he can do, but something that will deprive his children of the presence of a father.
In other words, his standard of living is going to be lower than either his father or grandfather.
I have a hunch he and his family are not alone.
I am afraid that what we are watching is the draining of America's wealth.
Ron Byers
May 12, 2006 6:23 PM | Reply | Permalink
Well, let's put some numbers on the case of our "widow" residing in one of America's "ten best places to live".
1966 "small house" purchase price=$25,000
2006 "small house" sales price=$425,000
Mortgage free; paid off 1990-1995
$425,000 sounds like "savings" to me.
May 12, 2006 7:14 PM | Reply | Permalink
Ron:
The authors of the book Empire of Debt seem to be conservatives. They have a website . They pretty much say the same thing you are saying. I am curious what you think of their thesis: that we are a empire in decline.
Find the Truth. Do Justice.
May 12, 2006 9:13 PM | Reply | Permalink
From that well known Book of Proverbs:
1. Never sell America short.
2. God looks after drunks, small children, and the United States of America.
May 12, 2006 9:58 PM | Reply | Permalink
Okie,
You practice in Oklahoma. What do you think? I live in a modest sized city north of you. It has been years since a big new plant was opened around here. The last one that did was very automated. More and more people are scrambling just to stay afloat.
Hardest hit are young men like the guy I mentioned above. You know the guys who played football on their high school team. The guys who tinkered with cars and drank beer. The guys who didn't go to Harvard. You know most everybody you knew growing up.
After high school those guys used to get a hard work job down at the pickup factory. They worked hard for 8 hours and went home. They made good money. Maybe, like the guy I mentioned, they went to junior college and learned a practical skill, and then they went to work at the factory or at the local car dealership. Maybe they worked construction. They got married to their high school sweethearts. They became fathers, hunted deer in the fall, drank beer and listened to country music on Saturday night and went to church on Sundays. They could afford and drove big pickup trucks. They could afford and lived in modest but comfortable houses. As they got older they drank less beer. They cleaned up their houses and yards. They sold their houses. They moved into bigger houses in the next subdivision. Sometimes, as they grew older, they bought a few acres on the edge of town and spent their Satudays mowing grass. The big fight was between the husband and wife. Hubby wanted wifey to stay home with the kids. For him it was a matter of pride, and a belief that was the way it was supposed to be. Wifey wanted a job to keep from going crazy. They proudly sent their smart kids off to the local college.
Those jobs at the pickup factory have either moved overseas or been automated out of existence. Both husband and wife have to work. Sometimes they have to work two jobs each. The kids are running free, unsupervised. Very few can afford to send their smart kids to college and, lets face it, unsupervised kids have problems.
If you think the problems are exclusive to the lower middle class (the folks who used to be the bedrock of this country) I have a friend who sent his two daughters to two of the 7 sisters. Those well educated young women couldn't find jobs after high priced college educations. After excellent adventures living off relatives in Manhattan they both moved home and lived with their parents. It was 6 to 10 years before either of them could find a job that paid well enough for her to live on her own. During that time they took a lot of anti-depressants and attended a lot of therapy sessions. Both of which would have been unnecessary had they been born a generation earlier when decent jobs were available.
No, I don't have a feeling that most Americans are living a dream so much as they are scrambling to avoid a nightmare.
Ron Byers
May 13, 2006 6:31 AM | Reply | Permalink
I'm hoping this is irony, but your past comments don't encourage optimism about that, Ellen.
May 13, 2006 7:58 AM | Reply | Permalink
Borrowing against your home to finance your expenses in retirement is not an ideal situation, but it's not necessarily a disaster. The problem I see coming in the near future, though, is too many Americans reaching retirement age with mortgages, car loans, and credit card debt still unpaid--and with no pension and very little savings. These folks may not have enough home equity available to cover their retirement costs. So they'll be working at Wal-Mart for ever and teetering on the edge of bankruptcy. It's probably okay to have a debt load of 100% or even 200% of your income when you're in your 30s and have just bought your first home. But if you're in your 50s or 60s and still have that kind of debt, you're headed for trouble.
May 13, 2006 10:53 AM | Reply | Permalink
I'm from that same patch of Oklahoma, and what you describe breaks my heart. It also describes what I'm finding in my research across the country.
It isn't just the poor or the lower middle class who are struggling. Now it is the very heart and soul of the American middle class who are fighting for survival. These are people who played by all the rules--went to college, worked hard, got decent jobs, bought homes and had kids. As they are taken out of the game, America undergoes a seismic shift. We move from a three- or four-class system (poor, working, middle, and rich) to a two-class system of those who are very-well-to-do and everyone else who is one pink slip or bad diagnosis away from complete financial collapse.
Flat incomes, rising costs AND rising risks are three powerful blows that threaten to knock out our middle class.
I believe in the middle class. They are fighters. But no one can survive these kinds of hits year after year after year.
May 13, 2006 11:21 AM | Reply | Permalink
A new report about ARMs in the Rocky Mountain News commented on by Calculated Risk blog.
Find the Truth. Do Justice.
May 13, 2006 1:36 PM | Reply | Permalink
The Debt Threat could eventually lead to "hyperinflation". The most recent example is what happened in Brazil. Do you suppose we should be concerned about that in this country?
Jim Anderson
The Truth About Credit
May 13, 2006 4:27 PM | Reply | Permalink
Hyperinflation? No. The Fed has shown on numerous occasions that it is perfectly OK with driving the economy into recession to avoid even a whiff of inflation.
May 13, 2006 7:40 PM | Reply | Permalink
No? Then why has the Federal Reserve stopped publishing the M3? The Fed distracts the audience with short-term rate hikes, while behind its back it monetizes long-term government bonds. It creates the illusion of its being an inflation fighter, while in reality it is an inflation creator. No wonder it wants to further cover its tracks by no longer reporting M3!
Did you realize that in March this year Iran switched its Oil Bourse over to PetroEuros from PetroDollars? If you wanted to buy oil on the global market, you had to pay dollars for it. This was one of the benefits of being the world's reserve currency. All the world's globally traded commodities were priced in dollars. In simple economic terms, that meant there was a built-in demand for dollars. That is changing. We are going to see a reduction in the demand for dollars, which will have the effect of devaluing our currency. The Federal Reserve will need to provide some way to buy them back. Remember, our currency is simply promissory notes. No wonder they no longer want to report M3!
Check the inflation since 1913 on the Federal Reserve Website for Minneapolis. One dollar of goods in 2006 buys the same goods for 5 cents in 1913. Is inflation really under control? At what point does it become excessive, and we lose confidence in it? England already went through problems with a Central Bank with a fiat currency and fractional reserves. Now the Pound is based on Sterling Silver and is the strongest currency in the world. Suppose we could learn something from that?
Jim Anderson
The Truth About Credit
May 14, 2006 8:05 AM | Reply | Permalink
Jim
Just a few months ago people worried obsessively about deflation.
Rushing back and forth worrying about things we seem unable or unwilling to control isn't going to restore the American dream for the millions of Americans who are struggling right now.
Ron Byers
May 14, 2006 8:36 AM | Reply | Permalink
Re: Did you realize that in March this year Iran switched its Oil Bourse over to PetroEuros from PetroDollars?
Who cares? The Euro is not a particularly stable currency these days and I would not bet any money on it (or the Iranian oil bourse) still being in existence in another twenty years. The dollar and the American economy in general may not be perfect, may not even be as sound as they once were, but compared to rest of the world we still have the healthiest and soundest currency in existence.
May 14, 2006 10:19 AM | Reply | Permalink
Those in the international financial industries can derive the M3 from various sources. If they find this measure useful they will do so. The general public never understood what M1, M2 and M3 meant anyway, so the lack of the data won't mean anything to them.
Unlike some other stats that the government has tried to suppress dropping this one won't have any effect.
--- Policies not Politics
Daily Landscape
May 14, 2006 12:36 PM | Reply | Permalink
Ron,
I've never worried about deflation, it is highly unlikey given the economic forces at work, and the manipulation of the Federal Reserve. I wonder if it would be healthy for our economy in the long run. I think that is what would happen if everyone started paying off debts in masse. It might hurt for awhile, but we'd be healthier for it. The Banks sure wouldn't like that - they'd shrink. It surely doesn't serve the Federal Reserve's interest.
I know it isn't PC to say this, but inflation can't continue forever before the dollar is worth nothing. Also, the federal government's debt eventually has to be paid. The lender always expects to be paid. We seem to be forgetting that. Maybe that forgetfulness is what contributes to our debt problem, publicly and privately. Did anybody even look at the articles I linked? Or is everyone ignoring what has happened repeatedly throughout history to fiat currencies, because we believe it can't happen to us? Are we in denial? We may be a big country, but we aren't immune to the laws of economics. We just fall harder.
My point is not to try to control it, but as individuals be ready for the consequences when they come. Controlling these forces is exactly what the Federal Reserve Bank is trying to do by manipulating its interest rates. All they are doing is building a dam against a force that will eventually overcome it.
Those of us who are prepared for debt to overwhelm our society will fare better. That means being free of debt when inflation gets out of control. That way you aren't strapped down to loan payments, and can concentrate more on the necessities without everything you own being reposessed. Talk to someone who lived through the depression and get their perspective.
Nobody wants to hear this, but neither democrats or republicans can change the laws of economics. Governments in the past have tried to defy them, and lost every time. It is a lot simpler than you think. The Federal Reserve Bank and the Federal Government make it sound complicated to keep us in the dark.
Jim Anderson
The Truth About Credit
May 14, 2006 5:07 PM | Reply | Permalink
Time to send the remainder of them Okies to Barstow and give the place back to the Comanche and Wichita. Time to restock the place with a few Bison bison, too.
May 14, 2006 5:41 PM | Reply | Permalink
Jim
I hear what you say and generally agree, but how do you propose Americans respond to your call for preparation.
In the last 20 years I have retired all of my credit card debt on three separate occasions. Twice I converted some investment real estate to cash and used the proceeds to pay off my credit cards. Once, when I was young, foolish and did PI work, I settled a very large PI case for a client and used my fee to pay all my bills (and a few other things.) In that case the credit card bills were a direct result of months without pay as I focused on the client's case. I got out of the PI business after a friend of mine, the best plaintiff's lawyer I know, lost a very expensive case and was forced to take bankruptcy.
By the way, I hate credit cards. I work hard not to carry credit card balances. That is not easy in months when, for reasons having to do with small office collections, I don't take much out of my office. I also have a high deductible health savings insurance plan. Running up a significant credit card charge is only an illness away.
I would be surprised if the average guy working for middle class wages ever has the same opportunity I have for big pay days. For them, retiring credit card debt is hard, hard work. Frankly, it is damn near impossible given the high interest rates charged by most card companies and the flatness of average wages in this country.
How does the average person get control of his credit card debt if he doesn't actually increase his income?
Ron Byers
May 14, 2006 5:58 PM | Reply | Permalink
Just a few months ago people worried obsessively about deflation.
Are these the same people who are worried about Bush enacting massive income tax increases on the upper brackets?
"You say I'm a dreamer. We're two of a kind. Looking for some perfect world that we both know that we'll never find." - Thompson Twins, "Hold Me Now"
May 14, 2006 7:42 PM | Reply | Permalink
Jim:
A couple of contradictory remarks. First, governments rarely pay off their debts. The US started with a million dollar debt after the Revolutionary war. Washington was in despair as to how it ever could be paid off. Our old friend inflation made it trivial.
Second, I agree there will be an economic downturn, I've been writing about it for a couple of years. Here's a sample: The Coming Crash. It won't look like the 1930's, however. We have many more economic cushions than we had then. Things like unemployment insurance, food stamps and social security didn't exist at the time.
Third, I also think we will see inflation and a currency adjustment, but who this will affect is not clear. During the Carter/Nixon inflation workers came out about the same as they went in. There was enough labor strength to insure that workers wages almost kept up with inflation. There were no variable rate loans so those with fixed rate loans came out ahead. Those who had lent money such as retirees owning bonds or annuities did poorly.
These days as the cost of borrowing goes up banks will be squeezed. They have already raised their rates on credit cards about as high as they can. Mortgage defaults may also cause problems, but most of these loans have been monitized and the losers will be holders of instruments from Fannie Mae and the like.
Since most people are now renting their lives they may not do too poorly. With no savings their capital won't deflate. So all in all the effects of the downturn will be variable and hard to predict.
As for advice to individuals, paying off high rate loans is always a good idea. Paying off fixed rate mortgages is probably not. Any excess cash should be put into safe, flexible investments such as one year bank CD's. You won't get rich, but you won't lose your capital either.
--- Policies not Politics
Daily Landscape
May 14, 2006 7:54 PM | Reply | Permalink
There are a lot of ways to approach it. Elizabeth Warren has an excellent book titled, "All Your Worth". I love her definitions of needs verses wants, and how to live on 50% of what you make, and use 50% as a cushion.
I think Dave Ramsey puts it pretty well. Have a credit card destruction party. People cut them up, cook them in the oven, microwave them, etc. They have fun with it. Then they commit to living on cash. Save at least 6 months expenses for emergencies and have the appropriate insurance. When you don't have to pay credit card interest, you will be amazed at how fast you can accumulate savings. Dave Ramsey has a good plan that makes it possible, in "baby steps". Complete one step before you move to the next - he teaches people how. See some testimonies on his website.
1. Save $1000 fast.
2. Start the Debt Snowball. (paying down debt)
3. Finish the Emergency Fund.
4. Invest 15% of your income in retirement.
5. Save for your kids college.
6. Pay off your mortgage.
7. Build Wealth (Invest)
I think if you just get completely out of debt - including your mortgage. You will be far better off than most people in any national financial crisis. Unfortunately, before you can do that successfully you have to admit there is a problem. Most people don't.
Jim Anderson
The Truth About Credit
May 15, 2006 6:41 AM | Reply | Permalink
Until the banks fail. FDIC or FSLIC insurance? Good luck.
At one point there was a surplus in the Treasury, and our economy was at its strongest because of it.
I believe it is likely that the World Bank/IMF will bail out the Federal Reserve Bank when inflation overtakes our currency, unless we get smart and follow the example of the British Pound. If we end up getting bailed out, we will probably start using the Euro instead of the Dollar. We'll start a new cycle of fiat currency, but this time not control it. (He who has the money, makes the rules) This time it will repeat the cycle on a world-wide scale. The governmental implications are scary.
Jim Anderson
The Truth About Credit
May 15, 2006 6:59 AM | Reply | Permalink
All worthwhile slogans, each one carrying the petina of moral superiority that makes the author feel smug about his own good fortune. Very Calvinistic to be sure.
Now, answer this question, just how do you expect the average American to make your slogans reality? People don't accomplish those goals because they don't want to, they don't accomplish them because they can't. Have you lived such a sheltered life that you don't realize that for most of us the system is rigged. The rich get richer and the poor get poorer.
Ron Byers
May 15, 2006 9:36 AM | Reply | Permalink
You obviously don't know much about Dave Ramsey. Did you read his testimonies? Thousands of people have overcome their debt using his methods, including their mortgages. He isn't the only way, but he has a unique approach, and makes it fun, with the Financial Peace University. Groups of people meet and share the experience, which makes it easier.
(I'll assure you I haven't lived a sheltered life.) The rich get richer at the expense of the poor, because the poor give their consent by taking out payday loans, credit cards, rent to own, etc. When you don't borrow, your hard earned money doesn't end up in the pockets of the rich.
The "baby steps" are not slogans. They are steps in a plan. There are a lot of things to do within each step to meet the goal of the step.
I agree, the system IS rigged, with a fiat currency, and the billions in marketing dollars being spent to convince us that debt is necessary. It is in the Federal Reserve's interest and the Federal Government's interest to have us spend, even if it means going into debt. Then they can say the economy is doing good. By doing so they have bid up prices, and made it even more difficult to buy durable goods without borrowing. We have a false sense of wealth.
The only way out is to admit there is a problem, and then wean yourself from the debt, by living within your means without debt. That is how you escape the trap this post is talking about! It isn't easy. That is why Dave's Financial Peace University groups are a good way to do this, they make it easier. You have peers that will support you while you support them. The peer pressure of spending to keep up with your neighbor's lifestyle is taken away. That is how average Americans are making the "baby steps" reality.
Jim Anderson
The Truth About Credit
May 15, 2006 2:56 PM | Reply | Permalink
You don't do yourself any favors by sounding like an alarmist. The FDIC can't fail, the government can just print money to cover whatever losses it incurs. The IMF can't bail out the US Treasury, where do you think it gets the bulk of its capital?
There are enough structural problems with our economy that require close analysis that nothing is gained by making extreme pronouncements.
--- Policies not Politics
Daily Landscape
May 15, 2006 4:57 PM | Reply | Permalink
Re: If we end up getting bailed out, we will probably start using the Euro instead of the Dollar.
If the dollar starts to go down the tubes, the Euro will already be down the drain. The days of indepedent economies and currencies are long past
May 16, 2006 4:37 PM | Reply | Permalink
Re: Second, I agree there will be an economic downturn
Well, that's a little like predicting winter: sooner or later it will happen
Re: Second, I agree there will be an economic downturn
Major inflation: no. For one thing inflaton, is a debntor's friend: he can pay off his debnts with cheap money.And for that reason the creditor class will never, ever let inflation get loose. And these are the people pulling the strings after all: see last year's bankruptcy bill
May 16, 2006 4:37 PM | Reply | Permalink
I guess we'll see. What will happen, will happen, or it won't. I prefer to be prepared for the worst. I've been burned living by the assumptions that seem to be conventional wisdom, and I've learned my lesson.
Jim Anderson
The Truth About Credit
May 16, 2006 5:24 PM | Reply | Permalink
Well, the Weimar Germans did not switch over to the Dollar or Pound in the 1920s so I fail to see any reason the US would switch to the Euro in a similar crisis. There's be nbo benefit to doing so taht I can see.
May 17, 2006 2:46 PM | Reply | Permalink
I don't believe it would be done enthusiasticlally, but we would have to issue a new currency, and the World Bank/IMF would most likely provide the means. The Euro is a fiat currency as well, managed by a "central bank" under the supervision of the U.N. They want the Euro to be a world currency, and would jump at the chance to add the U.S. to its users. All they have to do is issue enough new Euros to make the bailout loan to the Federal Reserve Bank. The FRB would then be subject to the wishes of its bailout lender.
As far as Germany is concerned, "Stresemann's first move was to issue a new currency, the Rentenmark, to halt the extreme hyperinflation crippling German society and the economy. It was successful because Stresemann repeatedly refused to issue more currency, the initial cause of the inflationary spiral. To further stabilise the economy, he reduced spending and bureaucracy while increasing taxes. He signed the Locarno Treaties with the Allied countries in 1925 as a means of restoring Germany's diplomatic status in Europe." (source Wikepedia)
How likely do you think it is that our government would reduce spending and increase taxes, when they could simply borrow the money to recapitalize the economy?
Jim Anderson
The Truth About Credit
May 17, 2006 8:47 PM | Reply | Permalink