Got Debt? Keep Digging

I was reading about several foolish consumers that have managed to get their credit card balances up so that their interest payments total more than 40 percent of their pretax income and thousands more in fees. Unfortunately, there are millions that are in the same boat.

Years of spending with easy credit have left a record number of Americans standing at the financial edge. They have amassed a mountain of debt that grows ever bigger because of high interest rates and fees.

It's clear that the past eight years of easy lending practices of America’s merchants of debt have led millions of Americans to the limit. More and more, Americans have little chance of paying off their debt.

It is not just individuals but the entire economy that is now suffering. Practices that produced record profits for many banks have shaken the nation’s financial system to its foundation. As a growing number of Americans default, banks are recording hundreds of billions in losses, devastating their shareholders.

To reduce the risk of a domino effect, the Bush administration created an emergency rescue plan for Fannie and Freddie.

Over the last eight years, the increased availability of credit has been the primary factor boosting the economy.

But behind the big increase in consumer debt is a major shift in the way lenders approach their business. In earlier years, actually being repaid by borrowers was crucial to lenders. Now, because so much consumer debt is packaged into securities and sold to investors, repayment of the loans takes on less importance to those lenders than the fees and charges generated when loans are made.

Lenders have found new ways to squeeze more profit from borrowers. Though prevailing interest rates have fallen to the low single digits in recent years, for example, the rates that credit card issuers routinely charge even borrowers with good credit records have risen, to 19.1 percent last year from 17.7 percent in 2005 — a difference that adds billions of dollars in interest charges annually to credit card bills.

Average late fees rose to $35 in 2007 from less than $13 in 1994, and fees charged when customers exceed their credit limits more than doubled to $26 a month from $11.

Mortgage lenders similarly added or raised fees associated with borrowing to buy a home — like $75 e-mail charges, $100 document preparation costs and $70 courier fees — bringing the average to $700 a mortgage, according to the HUD. These “junk fees” have risen 50 percent in recent years.

Today the focus for lenders is not so much on consumer loans being repaid, but on the loan as a perpetual earning asset.

Recent changes in the bankruptcy laws, supported by financial services firms, make it all the harder for consumers, especially those with modest incomes, to get out from under their debt by filing for bankruptcy.

For decades, America’s shift from thrift could be summed up in this familiar phrase: When the going gets tough, the tough go shopping. Whether for a car, home, vacation or college degree, the nation’s lenders stood ready to assist.

Companies offered first and second mortgages and home equity lines, marketed credit cards for teenagers and helped college students to amass upward of $100,000 in debt by graduation.
Every age group up to the elderly was the target of sophisticated ad campaigns and direct mail programs. “Live Richly” was a Citibank message. “Life Takes Visa” proclaims the nation’s largest credit card issuer.

Eliminating negative feelings about indebtedness was the idea behind Mastercard's “Priceless” campaign, which came out in 1997.

Mortgage lenders took to cold-calling homeowners to persuade them to refinance. Done to reduce borrowers’ monthly payments, serial refinancings allowed lenders to charge thousands of dollars in loan processing fees, including appraisals, credit checks, title searches and document preparation fees.

Not surprisingly, such practices generated dazzling profits for the nation’s financial companies.

And since 2005, when the bankruptcy law was changed, the credit card industry has increased its earnings 25 percent.

The 2005 bankruptcy reform was designed by creditors to benefit credit card companies and hurt their customers.

Because many of these large institutions pool the loans they make and sell them to investors, they are not as vulnerable when the borrowers default. At the end of 2007, for example, one-third of Capital One’s $151 billion in managed loans had been sold as securities.

As the profits in this indebtedness grew, financial companies moved aggressively to protect them, spending millions of dollars to lobby against any moves lawmakers might take to rein in questionable lending.

Just two generations ago, America was a nation of mostly thrifty people living within their means, even setting money aside for unforeseen expenses.

Today, Americans carry $2.56 trillion in consumer debt, up 22 percent since 2000 alone, according to the Federal Reserve Board. The average household’s credit card debt is $8,565, up almost 15 percent from 2000.

College debt has more than doubled since 1995. The average student emerges from college carrying $20,000 in educational debt.

Household debt, including mortgages and credit cards, represents 19 percent of household assets, according to the Fed, compared with 13 percent in 1980.

Even as this debt was mounting, incomes stagnated for many Americans. As a result, the percentage of disposable income that consumers must set aside to service their debt — a figure that includes monthly credit card payments, car loans, mortgage interest and principal — has risen to 14.5 percent from 11 percent just 15 years ago.

By contrast, the nation’s savings rate, which exceeded 8 percent of disposable income in 1968, stood at 0.4 percent at the end of the first quarter of this year, according to the Bureau of Economic Analysis.

More ominous, as Americans have dug themselves deeper into debt, the value of their assets has started to fall. Mortgage debt stood at $10.5 trillion at the end of last year, more than double the $4.8 trillion just seven years earlier, but home prices that were rising to support increasing levels of debt, like home equity lines of credit, are now dropping.

The combination of increased debt, falling asset prices and stagnant incomes does not threaten just imprudent borrowers. The entire economy has become vulnerable to the spending slowdown that results when consumers hit the wall.

Bottom line - until consumers get their debt down or gone, we're in for a long grinding bear market with lots of bear market rallies.

The Best Money Guy.

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