Credit Basics
Debt Loan makes Americans vulnerable to rising rates
by
Associated Press
Monday, August 29, 2005
EDITOR'S NOTE -- Growing debt has long been a concern in the United States, from individuals buying on credit to Washington budgets. But many economists are now warning that runaway spending and borrowing have the nation on track toward a major economic crash. The second in a three-part series, this story looks at scenarios in which debt could cause a major economic setback.
NEW YORK (AP) -- Buy now, pay later: It's been the mantra of American consumers for decades.
The results are obvious in the ballooning balances on credit cards and mortgage
loans, and in the mushrooming U.S. trade deficit, which reflects the nation's nearly
insatiable appetite for cheap, imported goods.
Low interest rates, especially since the end of the 2001 recession, have fed the
debt beast at home, allowing American consumers to accumulate nearly $11 trillion
in debt as they buy more homes, more cars, more clothes, more dinners out. At the
same time, foreign investment in the United States is helping to keep the dollar
strong, which holds down prices on those imports Americans covet.
But what would happen if interest rates suddenly weren't so benign, or if foreign
governments, corporations and individuals stopped investing so heavily in America?
Some analysts fear such actions could trigger doomsday scenarios in which the bills
come due and Americans can't pay. The consequences could be devastating for the
U.S. economy.
The Associated Press asked several experts to discuss these potential disasters
and to offer a rebuttal for those who believe that while the country may be in debt,
it's not in danger.
CREDIT CARD CRUNCH
The tool that has made it ever so easy for Americans to buy and buy is the credit card. And buy they have.
Outstanding balances on credit cards have risen to more than $800 billion, or some $7,200 per U.S. household. It's more than double the indebtedness of a decade ago -- and it doesn't include an additional $1.3 trillion in debt for cars, appliances and personal loans.
What if interest rates suddenly shot up, say 3 percentage points or 4 percentage
points, requiring burdened borrowers to greatly increase the amounts they have to
pay each month on their debt?
"It would undermine the housing market, and could quickly result in credit problems
that would affect the entire (American) financial system," says Mark Zandi, chief
economist at Economy.com, a forecasting firm in suburban Philadelphia.
Such an event isn't beyond the realm of possibility if global investors, for instance, shift their money out of the United States or if a terror attack riles financial markets. THE REBUTTAL: Skeptics don't see a big economic shock in the
Some American borrowers already are in trouble, and more are likely to stumble as interest rates rise and the new bankruptcy law makes it harder for consumers to be relieved of their debt, said Howard Dvorkin, head of Consolidated Credit Counseling Services Inc. in Fort Lauderdale, Fla.
"You'll see creditors get more aggressive at collecting debt, the reason being that they can," Dvorkin says.
That will turn many borrowers into "the walking wounded," struggling to keep up with card payments and limited in what they can buy -- a massive drag on the U.S. economy.
offing. Economy.com's Zandi says interest rates are most likely to go up at a measured
pace, giving most consumers time to adjust to higher payments, and some may see
their credit limits cut.
Still, much of the recent debt has been taken on by lower-income and lower-middle-income
families, who borrowed aggressively to maintain their standard of living as wages
stagnated. "Going forward it will be harder for them to maintain their spending
-- and their living standards," Zandi says.
MORTGAGE MANIA
Americans have taken on more than $8.8 trillion in mortgages to buy homes, up an
astounding 42 percent since the 2001 recession. And rapidly rising prices in recent
years have made many homeowners feel wealthy, so they've ramped up day-to-day spending.
But that run-up in prices -- what Federal Reserve Chairman Alan Greenspan has described
as "froth" -- increasingly looks like a bubble.
"The bigger bubble is actually in the financing of homes," says economist Ed Yardeni
of Oak Associates in Akron, Ohio. Millions are buying homes with no down payments.
Or they have adjustable-rate mortgages or interest-only mortgages or optional payment
mortgages.
