Living with Debt

In recent years there was a drastic change in personal economic thought - once upon a time debt was frowned upon. However recently debt was equated with wealth. As long as one had a new car, granite countertops and a coach bag it did not matter if one could afford it. Whether the procurement was done through debt or cash in hand was irrelevant. And due to easy access to equity it was even easier. Once people had run up their credit cards they often just threw the debt into their home equity lines.

Now that property values have plummeted people have to change their ways. Credit card debt is still increasing but the ability to convert it into equity debt has abruptly stopped. This issue is examined in this article from the Washington Post titled Banks hoards cash as credit card defaults rise. We can see that the debt problems have been continually increasing. Lets take a look -

The deterioration in consumer credit, the latest downturn to whack Americans after the housing slump and mortgage meltdown, threatens one of the linchpins of the U.S. economy. Over the past 10 years, credit card debt has gone up 75 percent as Americans' real wages and savings rate have stayed flat. That means Americans have been spending beyond their means -- and fueling economic growth with borrowed money.

Now, the housing crash, financial downturn and contracting economy have made it more difficult for Americans to settle their bills, setting off a downward spiral. As people fail to pay off their credit card bills and other loans, banks must put away money to cover expected losses. So banks lend less. Americans who tended to rely on loans to fuel their spending must cut back, readjusting their spending habits to conform with what they earn.

"Given that the savings rate has been minuscule, there's no reserves in the tank for the consumer to tap his savings to support his spending," said Scott Valentin, a financial services analyst at Arlington investment bank Friedman Billings Ramsey. But consumers have been driving about two-thirds of the U.S. economy.

...
A report this week from Innovest, a research firm, said banks and other credit card lenders could record nearly $100 billion in losses because of bad loans through the end of next year. Innovest said financial firms could be reaching a "tipping point" at which years of growth in credit card debt starts to decline.

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Credit card debt is especially worrisome for banks because it is not backed by real assets, such as home mortgages and auto loans. But that has meant credit card issuers routinely have been more cautious.

Which brings us to the Innovest report. First lets take a look at the savings rate Vs. debt Ratio the provide-

Our debt is significantly higher than our savings. This is not viable in the long term.

Now onto an Innovest graph that illustrates the huge divergence between credit card debt and real wages.


With a such a significant gap the money has to come from somewhere. And then lets compare the previous graph with one from Calculated Risk illustrating quarterly rise and fall of equity withdrawal.


These are some pretty frightening graphs depicting just how much we have been accustomed at living well beyond our means. Just living within our means will hurt. Our debt has become a great burden that will make any recession even harder. The fact that we do not have any savings to fall back on will make things even gloomier. The next few years are going to be pretty rough.