NEWS ANALYSIS : Americans’ Debt Load Could Slow Pace of Recovery : Finances: Some economists contend that consumers haven’t reduced their obligations much, they’ve simply shifted them to other types of financing, such as equity loans.
Are American consumers reducing their debt burdens?
A small but growing number of economists say no. And if they are right, the nation’s economic recovery may be slower and more painful than previously believed.
Conventional wisdom holds that American consumers, nervous about layoffs and meager pay raises, are paying down debt taken on in the go-go 1980s. And indeed, the economic ledger kept by the Federal Reserve shows steady declines in auto loans, personal loans and other kinds of consumer debt.
Appearing before Congress recently, Federal Reserve Board Chairman Alan Greenspan said debt payments now gobble up a much smaller portion of Americans’ paychecks. Thanks in part to lower interest rates, monthly payments on mortgages, auto loans, credit cards and other debts now eat up 16.7 cents of every after-tax dollar, compared to 18.2 cents about 18 months ago, he said.
But economists outside the government who keep their own books on consumer debt are starting to challenge the Fed’s conclusions. These economists contend that consumers haven’t reduced their debt obligations much at all; they’ve simply shifted the borrowing around to other types of financing such as home equity loans and auto leases. And the Fed, relying on outdated methods, doesn’t count such sources of debt.
Though it may seem esoteric, the debate among economists is much more than an academic exercise. It relates directly to the timing and strength of any economic recovery, and a return to a period of steady wage growth and job stability.
Economists on both sides of the debate agree that a surge in consumer spending is needed to get the economy moving again. But consumers aren’t going to take on new debt for cars, appliances, homes and furniture until a good chunk of the old debt is paid off, experts say. The pace of consumer debt reduction is, therefore, crucial.
Citing repayment of consumer debt, Federal Reserve Vice Chairman David Mullins recently told a New York financial group that a 3% increase in economic growth was possible by the end of the year. Debt reduction on the part of consumers and business, he said, was “systematically laying the foundation for a healthy economy.”
Not surprisingly, a leading critic of the Fed’s consumer debt estimates offered a sharply lower growth forecast. First National Bank of Chicago economist Diane Swonk contended that the economy will expand by a scant 2% this year.
The gap in growth projections is a significant one; it is generally accepted that a 2.5% growth rate is necessary to create jobs.
“People waiting for the economy to bounce back and consumers to rush to stores are going to be disappointed,” Swonk declared. “The consumer is leveraged to the hilt . . . more deeply entrenched in debt than ever.”
Swonk contended that consumers devote nearly 27 cents of every after-tax dollar to debt payments--by her reckoning, virtually unchanged since 1990. Her estimates are higher than those put out by the Fed because they include home equity loans and auto leases, increasingly popular forms of financing that are not fully reflected in the Fed’s consumer debt figures.
Independent estimates show that home equity loans and auto leases have grown rapidly during the past recession, even as other kinds of financing have declined.
The Washington-based Consumer Banking Assn. said home equity lines grew by 14% last year to $132 billion outstanding. One-third of that amount was used to consolidate existing debts, the banking group said, while nearly 11% was used to finance car purchases.
Meanwhile, the value of consumer auto leases is expected to swell to $30 billion this year, up from $20 billion a year ago, according to CNW Marketing Research, based in Bandon, Ore. Art Spinella, CNW director of research, said one-quarter of cars delivered to consumers this year will be leased, primarily because leases require no money down and offer low monthly payments.
Because an auto lease is not generally considered as debt, it is not reflected in the government estimates on consumer debt. Swonk and others argue that it is a mistake to ignore auto leases, because they have become, for many consumers, a substitute for debt. And, said Nashville, Tenn., leasing expert Randall McCatherine, auto leases are written for a term of four years while loans are commonly three years. This means that lease obligations sit on a consumer’s personal balance sheet longer.
More significant, economists say, is the refinancing of existing debt with home equity loans.
Swonk said that as interest rates declined over the last 18 months, consumers refinanced expensive credit card, auto and other debt with lower cost home equity loans. As this occurred, some of the debt disappeared from the Fed’s official ledger, but not from homeowners’ balance sheets.
From a homeowners’ perspective, refinancing debt at lower rates makes sense because it reduces the size of the monthly debt payment, freeing up cash for other uses. Swonk, pointing to a burst in retail sales earlier this year, said she believes that consumers have already spent their windfall. A drop in the savings rate in June, Swonk said, suggests that consumers have still too much debt.
Though regional estimates are hard to come by, experts say that trends in home equity loans and auto leasing have implications for Californians.
The National Vehicle Leasing Assn. reports that California is among the nation’s most active auto leasing markets. The state’s consumers apparently have a big appetite for home equity loans as well; Wells Fargo Bank and Bank of America, both based in California, are among the nation’s top home equity lenders.
Regional Financial Associates, an economic research firm, estimates that Californians and residents of other Western states use 25 cents of every after-tax dollar for debt payments. Midwesterners use only 17 cents of every after-tax dollar for debt payments. The figures include mortgages, but not home equity lines.
Even those who believe that the debt burden may be shrinking contend that it is not doing so quickly enough. Economist Bruce Steinberg of the Merrill Lynch brokerage firm said that during the two recessions preceding the most recent one, the nation’s debt fell by 3.4% and 4.3%, respectively, as Americans, helped by healthy 5% to 6% gains in disposable income, paid off debts.
During the latest slump, Steinberg estimated that real debt declined by only 2.3%, not enough of a drop to spark another round of borrowing. With disposable income growing by only 2%, he said, Americans will have a hard time reducing their debt further.
“Households are attempting to reliquefy, but they are having a hard time doing that,” he said. “Income growth is so slow that consumers are not able to jack up the savings. This makes the whole process very, very slow.”
With the refinancing binge mostly over, economists don’t expect consumer debt to fall significantly, barring an unexpected boost in incomes.
“We’re not talking collapse,” Swonk said. “We’re more talking spinning our wheels. This is life in the ‘90s, the pay-back decade.”
Consumer Debt: Just How Big?
Home equity loans are rising...
The value of outstanding home equity loans made under lines of credit by commercial banks:
Year / (billions of dollars) 1987: $30.6 1988: $40.0 1989: $50.8 1990: $61.4 1991: $70.2 Source: Federal Deposit Insurance Corp.
Year 1991: Adjusted Debt-to-Income Ratio**: 25.8 Fed Debt-To-Income Ratio*: 17.3
Source: First National Bank of Chicago * Includes auto loans, credit card debt, personal loans, home improvement loans, mobile home loans and student loans. ** Adjusted to also include home equity loans and second mortgages.
