More Debt, Fewer Paychecks Spell Trouble for Economy
As layoffs mount and the nation teeters toward a recession, consumers’ heavy debt load is looming as a serious risk for many American households and the economy.
Consumers who have been spending freely--relying heavily on their credit cards--have been propping up the U.S. economy.
But credit card delinquencies hit a 29-year high recently, before the Sept. 11 terrorist attacks further eroded consumer confidence and the job market.
Jobless benefits claims reached a 10-year high last week, the government reported Thursday. And many economists are expecting today’s labor report to show that businesses slashed about 70,000 jobs in September, a figure that does not include the tens of thousands of layoffs announced by airlines and hotels after the surveys. In the previous six months, about 264,000 jobs evaporated.
More debt and fewer paychecks spell trouble because the combination makes consumers retrench. And consumer spending makes up two-thirds of the economy.
“Delinquencies are going to rise, bankruptcies are going to rise, and they’re going to cut back on their spending,” said Mark Zandi, chief economist at RFA Dismal Sciences, a consulting firm in the Philadelphia area.
A sharp increase in defaults and bankruptcies could make banks reluctant to generate loans. “If that happens,” Zandi said, “the problems for the economy are going to grow very deep.”
Certainly Craig Fein, 42, is worried about his $9,000 credit card balance. Fein lost his $43,000-a-year job at a commercial printing company last Friday, a layoff that his company blamed partly on slowing business tied to the terrorist attacks. Looking for ways to cut corners, the Buena Park resident and his wife have decided to give up their cell phones, earthquake insurance and newspaper subscription. And they’re planning a much leaner Christmas.
“I’d have to go back many years to recall being this frightened about my career and my finances,” he said.
Fein’s credit card balance is higher than the national household average, which ballooned to more than $8,100 last year from $3,000 in 1990, according to CardWeb.com.
For Fein and many other borrowers, the Federal Reserve’s interest rate cut earlier this week won’t help much. Even though the Fed’s key short-term interest rate has been whittled down to a 39-year low of 2.5%, the average annual interest rate on the standard credit card still is more than 14%. On a balance of $9,000, that amounts to about $100 a month in interest payments.
Until recently, these rates didn’t stop households from wielding their plastic. Even as the stock market struggled and once-plump retirement funds slimmed down, many consumers remained quite optimistic about the future. Jobs seemed secure, home values were rising.
Many felt no need to stop borrowing and spending.
Mike Barber, a 39-year-old construction worker has enjoyed lavishing gifts on his 4-year-old son. Today, he owes about $15,000 on his credit cards and has a new Ford Mustang to pay off. The Anaheim construction worker still has a job, but his company has been laying off employees recently, which made Barber edgy enough to visit the state jobs office earlier this week to check out job listings.
“I figure my name’s coming up pretty close to the top of the list,” he said.
Many people “were just doing what they thought made sense” as they rapidly built up debt in the 1990s, said Dean Baker, co-director of the Center for Economic and Policy Research, a liberal think tank. “Suddenly, they find themselves in a very tight situation. . . . They’re way short of where they intended to be.”
Now, borrowers are going to have to reduce their debt, which “can be a very, very hard thing on the economy,” Baker added.
Experts differ on how hard it will be on the economy if consumers keep their wallets closed for an extended period of time.
“It certainly can prolong a recession,” said James Chessen, chief economist for the American Bankers Assn. “You need consumers to spend to drive the economy, to create jobs. So by not spending it actually makes the situation worse overall.”
Because of the terrorist attacks, Chessen expects an economic downturn for the rest of the year, a particular blow to retailers who count heavily on holiday shoppers.
“Can they get consumers out to the malls when they’re into this hunker-down mentality?” Chessen asked. If not, he said, the negative effect on the economy could spill into the next year.
But Peter Kretzmer, senior economist for Bank of America, doesn’t think consumers will stifle their spending enough to force a severe downturn.
“I don’t think it’s in the cards, not with the monetary situation being what it is,” he said, referring to interest rate cuts and a promised boost in federal spending to stimulate the economy.
The Fed’s aggressive interest rate trimming this year has lessened the damage caused by the slowing economy, experts say. Lower rates, along with rising home prices, have fueled mortgage refinancings that have allowed many homeowners to consolidate debt--or keep spending.
Of course, credit card balances aren’t the only problem. Late payments for cars and other debt also are rising. Earlier this year, household debt service--interest and principal payments as a share of Americans’ take-home pay--was near the all-time peak reached in 1986.
Further, delinquencies on Federal Housing Administration mortgages hit a record 10.79% in the second quarter, an indication of how much lower-income homeowners are feeling the pinch.
Lower-income households have amassed a disproportionate share of debt and have little cushion to protect them. Many of the thousands of workers laid off after last month’s attacks were among lower-wage earners, including maids, waiters, cooks and dishwashers.
Meanwhile, wage earners of varying levels--including hotel and airline workers--have kept phones ringing at Springboard Nonprofit Consumer Credit Management, boosting call volume by 25% since Sept. 11, the Riverside agency said.
“The ripple effect of these attacks is just huge,” Chief Executive Dianne Wilkman said. “We’re setting more appointments than ever.”
