IOU

When I heard that average household debt in the US was over $90,000, I went on line to find out some of the details.  I found that the $90,000 number was the amount owed spread out over all households.  Considering that about 30% are debt-free, that means only the households that are in debt owe an average of over $130,000, an even more surprising number.

This personal debt includes student loans, mortgages, credit cards and auto loans.  Now averages are tricky and summing averages does not necessarily represent reality, but such a large debt while we hear constant reports of stagnant income for the middle class is still a matter for concern.

While I was looking for the details, I ran across this article about a similar problem in Australia.  Their “household debt has skyrocketed to 185 per cent of disposable income and continues to soar.”  They blame the problem on a combination of “ill-considered public policies and lifestyle and investment choices of individual households.”  Driving these personal spending and investment choices are artificially low interest rates and other government policies and programs that discourage savings and encourage borrowing.

The article predicts that in less than five years the household debt bubble will burst leading to widespread economic hardship for those who have incurred unsustainable levels of personal debt.  As a remedy to avoid the crisis, they recommend that the Australian central bank, analogous to the Fed in the US, raise interest rates to discourage borrowing.  This will cause some short-term pain, but will avoid a likely major economic upheaval if behaviors don’t change.

This story of Australia and the urgency with which it was written made me curious about the corresponding number for the US.  I found an estimate of the household annual disposable income for the US of $41,355.  If this is, in fact, the same calculation, the average household debt in the US is not 185 per cent of disposable income – it’s almost 220 per cent!

Should we be as panicked as the Australians?  I’m not sure.  But it seems to be at least a wake-up call about personal borrowing and spending.  Overspending is a discipline issue and the consequences, whatever they are, will catch up sooner or later.

Looking for Excuses

Are ethics becoming more situational?  I occasionally hear someone making a comment about getting something for free because the company is not paying attention or because they have found a way around paying: free cable or extra channels, a new cell phone after intentionally destroying the old one before the insurance runs out, free videos and music, etc.  They justify this by saying that the company is big and probably unethical and takes advantage of customers.  This becomes their personal administration of punishment.

Recently, in response to HBO CEO Richard Pepler’s comment that he doesn’t mind people sharing their logins to watch shows online, Emmys host Andy Samberg decided to share his login on national TV – humorous perhaps, but not exactly in the spirit of honesty.  Many jumped at the opportunity to get something for nothing.  According to Variety, “the account quickly hit login limits and has now been deactivated.”  Accordingly, a Consumer Reports survey found that, “46% of American adults said they shared log-ins for streaming media services with people who were not part of the same household—which is generally against the rules.”  It used to be called stealing, but what the heck.  They are big companies with plenty of money.

The government gets the same treatment.  Polls show that approximately 87 percent believe it is unacceptable to cheat on income taxes, which leaves almost 1 in 7 who think it’s OK.  That’s what they say, but “economists estimate the size of the underground [cash] economy at somewhere between 8 percent and 14 percent of total GDP, which could amount to as much as $2 trillion worth of economic activity.”  This is probably not the same 13% of people.  In addition, I told in May 2013 how 99% of taxpayers neglect to report sales tax on Internet purchases and 30% said they would change their shopping habits if a tax were charged at the time of purchase.  No twinges of conscience nag at ordinary citizens when it comes to shorting Uncle Sam or their state department of revenue.

Meanwhile, politicians and their supporters think an acceptable defense is not that they are innocent, but that others before them did the same or worse.  (In many cases voters just shrug off these excuses as if we don’t expect better.)

When the housing crisis struck several years ago, a prominent economist actually encouraged people to default on their loans.  He argued that a smart economic move of walking away from a house worth less than the amount still owed superseded any ethical constraint.  The government was bailing out big companies, so it wasn’t fair for the little guy to be stuck in an upside-down mortgage situation.  One study found that about 17% agreed with this conclusion, but among those who knew someone who had “strategically defaulted,” 82% were likely to agree.

As the left and the right continue to demonize big business on one hand and the government on the other, are we making it easier to justify cheating?  If it is difficult to do business now – getting loans or qualifying for service – what will it be like in the future if companies cannot trust their customers to live up to commitments or expect the public in general to play by the rules?  This behavior too will have consequences.

Economic Understanding

Economic Understanding is one of the key dimensions, but what is so important about it?  I have given several examples over the years showing how people make poor decisions when they fail to connect outside spending with their own financial welfare:  insurance claims raising the cost of insurance for everyone, legal settlements driving up the prices we pay, shoplifting affecting honest shoppers, businesses passing along the cost of government regulations, etc.

Another side of economic understanding is being able to predict unintended consequences of artificial interference in the normal course of business.  I have written several times about more insurance not being the answer to high medical costs, whether it be the current plan or some alternative.  (See April 16, 2012, September 10, 2012, February 22, 2013, October 28, 2013)  This prediction continues to come true.

A recent Huffington Post article tells of the impending doctor shortage.  How do you add millions of people to patient roles (by providing them with subsidized insurance) without adding more primary care physicians?  Doctors’ time doesn’t magically expand; new doctors don’t magically appear.  They must be trained and hired.  “According to the Association of American Medical Colleges (AAMC), unless something changes rapidly, there will be a shortage of 45,000 primary care doctors in the United States (as well as a shortfall of 46,000 specialists) by 2020.”

Using our economic understanding we can predict that hospitals will be bidding for those few doctors which will drive their costs up.  Patients will be forced to “pay” through extended waiting times or searching among the dwindling number of doctors who are accepting new patients.  “Many primary care doctors and dentists do not accept Medicaid patients because of low reimbursement rates, and many of the newly insured will be covered through Medicaid. Many psychiatrists refuse to accept insurance at all.”

On the surface the proposals look so enticing:  Insurance for everyone must be a good thing, caring and compassionate.  In the richest country in the world, why doesn’t everyone have access to quality health care?  The argument is compelling, but economic reality provides a brutal wake-up call.  Notice what happened about ten years after the government decided to make home ownership, “the American Dream,” available to more families.  Notice that college prices continued to climb even after the introduction of grants and “subsidized” loans – leaving graduates today with $29,000 debts.  It was not until colleges saw a reduction of state support and viable competition from tech schools and especially on-line courses, in other words real economic pressures, that they felt a need to drive down tuition costs.  The well-meaning proposals and programs often have the opposite effect.

If politicians and the voters they appeal to had a better economic understanding, some of these decisions, innocent and caring as they may appear, might have been questioned based on predictable negative consequences.

Credit Where Credit Is Due

According to this USA Today article, household debt in the US is shrinking.  “Consumers went into the recession carrying debt of nearly double the nation's gross domestic product. That's down to below 85% now, and on pace to approach 75% by late next year.”  My first reaction was, “Good for us!”  Americans are showing more discipline with their spending.  This is a good, long-term sign.  Being overextended affects our physical and mental health as well as our ability to cope with financial emergencies.  As we found out not too many years ago, when too many people take on too much risky debt, we face serious societal consequences.

The article states that this debt reduction is a good short-term sign; because when we once again get comfortable with our debt level, spending will increase, leading to more consumption, more jobs and higher economic growth beginning as early as next year.  The slow recovery in home equity is seen as the only problem.

I don’t have anything against economic recovery, but let’s not be too hasty.  First, disregard home equity.  As I have argued in the past, you will always need a place to live.  Regardless of what we hear from realtors, loan officers, investment advisors, and others who profit from the transaction, to think of home equity as an investment is self-deceptive.  Second, let's try to minimize other debt.  There are simple ways to minimize or eliminate auto loans, and people who pay off their credit cards every month are the banks’ worst nightmare.

How many times do we have to be hit over the head before we are more careful about borrowing money by delaying gratification, prioritizing wants over needs, and treating debt as an obligation or burden rather than as a convenience?  It’s only been a few years since bad borrowing decisions and pursuit of extravagance plunged us into a recession, whose negative effects still linger.

Yes, when I saw that news, I was encouraged about the potential for improved behavior in financial discipline.  I was not even discouraged by another article telling how a big chunk of the decrease in debt is attributable to defaults and foreclosures.   When the bank writes it off, the debt goes away – but comes back to haunt the rest of us as higher fees and restrictive lending policies.  (Remember, we are all connected by that economic web; there’s no magic money tree.) 

Long-term, a new sense of financial discipline can be a very good thing for America.  It will take willpower and patience, but it’s worth it to avoid the well-known consequences.  (If you still think the last recession can be blamed on banks and Wall Street, you missed this.)  And once we get our personal houses in order, perhaps we can force our government to do the same.

Who's to Blame for the Great Recession?

Let’s agree first that the primary cause was the bursting of the housing bubble.  Mortgages went bad.  People moved out or were evicted from homes they could no longer pay for, leading to a housing surplus, leading to declining prices, leading to more people moving out or stopping payments on first or second homes that no longer seemed to be a good investment because they owed more than the houses were worth.  Since people had used their home equity to continue spending, a drop in value meant that people stopped spending.  Jobs that depended on that spending went away, jobs in construction, but also those associated with other expenditures, big and small.  Then the domino effect took over and unemployment soared.

If you have been following this blog, you know I intend to show that this mess is related to our failure in personal behavior.  Let’s see how we get there.

Every transaction has two parties, a buyer and a seller.  This applies to every bad mortgage that contributed to the housing boom and subsequent bust.  Granted, some of the brokers and bankers were real weasels.  They issued loans with teaser rates.  They talked people into interest-only loans.  They approved borrowers without adequate proof of income.  They did everything possible to initiate loans and collect their fees without regard to the borrowers’ ability to pay.  They sold those loans to Wall Street banks to be repackaged, insured with complex derivatives and to become the subject of other unsavory activities.  Everyone wrongly assumed that prices (and incomes) would continue to rise allowing even marginal buyers to refinance (for more fees) when the teaser rates ran out.  Now everyone is sure that the bankers are the villains and the borrowers are the victims.

I beg to differ!  For every transaction there are two parties.  Someone had to sign on the bottom line, take the money and move into a house they could not afford (knowingly or unknowingly).  Are we to assume that all these people were gullible or stupid or unable to save for an adequate down payment?  Is this a fair assessment of our fellow citizens?  Assigning the victim label shows either arrogance or shame, feeling superior for having not messed up ourselves or embarrassment for having been so careless.

They weren’t victims.  (Legally questionable acts by the banks disclosed so far have been on the foreclosure side, not on the loan origination side.)  The borrowers were lured by a culture that encourages going into debt to satisfy our current cravings.  The bankers took advantage of a mindset that was already in place – buy now, pay later.  It is a culture we reinforced for years.  Every time we were given an opportunity to buy on credit (not wait and save up), we took advantage of it, rewarding with our patronage the companies that made it possible.  

There was a time when being in debt was a disgrace, an embarrassment.  Not that long ago, people expected to put money down on a house or a car and pay it off over a reasonable period.  They would celebrate burning the mortgage.  The mindset changed to putting as little down as possible to taking advantage of financial leverage, then using the equity to finance our cars, toys and vacations.  We are all paying the consequences of this foolish, risky behavior.

Where would the bankers and brokers be if the majority had acted according to traditional values and expectations?  They wouldn’t be the villains, because there would be no villains.  Remember, there is not a company or a bank that can stay in business without our support, directly or indirectly.  Their business is to get us to freely spend our money on their goods and services.  Following the traditional values may have grown the economy more slowly, but isn’t that better than the roller coaster we have been on?  Perhaps fewer people would have been able to buy houses, but isn’t that better than having millions of houses standing empty?  Is it so terrible to pay rent for a few more years?  Wouldn’t everyone be better off – with the exception of a few bank and hedge fund executives who walked away with huge bonuses based on false profits? 

Who’s to blame?  We are – for lacking the discipline to save before spending and the perspective to distinguish between wants and needs – want a house, want it now, not willing to wait!  Now we want to compound the error by denying responsibility and claiming victimhood, leaving us in a position to repeat the same types of errors (and consequences).  You can say bad things about the evil bankers with their big bonuses, but don’t forget that each of those transactions had two sides!