April 23, 2007

Why High Consumer Debt?

Today's question is only slightly less controversial than asking how much of intelligence is nature and how much is nurture: How much of consumer debt is due to personal bad behavior (inability to delay gratification) and how much due to rising costs combined with stagnant raises?

First, I note that it doesn't matter how much people are in debt. It only matters how much debt they have relative to income. Debt levels will naturally go higher over time as salaries increase. So the next time you see this headline:
Consumer Debt Reaches All-Time High!
...you can yawn.

The only thing that matters is the relation of debt service payment to income. Household debt as a percentage of disposable income, when too high, affects not only the individual debtor but the whole financial house of cards. Recessions occur and unemployment goes up when payments get too high. Your neighbor gets in debt too much and you lose your job - we're all connected.

Some blame it on higher fixed expensives. This appears to be the Elizabeth Warren tack. She blames high home and car payments as well as education costs. This sounds good but then one sees that higher home costs are due to rising McMansions. It's sort of hard to feel sorry about higher home costs when part of what is driving that cost is a spa in every bathroom, huge kitchens and 2500+ square foot houses.

In fairness, Warren says that families buy homes they cannot afford in order to live where the schools are good. That helps make the anti-materialistic argument: daggone it, I have to live in luxury so that my children can go to good schools. But there's no question that schools vary greatly, in part because of bad parenting and powerful teacher's unions.

But is the real evil fixed debt or credit card debt? Adam J. Goldstein wrote a University of Illinois Law Review article, quoted here:
The rapid increase in consumer indebtedness in the U.S. has been largely confined to credit cards and has not characterized other types of consumer credit. "This indicates that there is something singular about the design of credit cards that uniquely causes people to accumulate too much debt," Goldstein wrote.

Several features of credit cards make them different from traditional forms of lending and encourage high levels of consumer debt by taking advantage of "consumers' cognitive and behavioral vulnerabilities," Adam J. Goldstein wrote.

When issuing loans for cars, home mortgages and other forms of debt, banks conduct a thorough credit screening of applicants. But when the same banks issue loans in the form of credit cards, "people with bad credit histories, as well as those who have declared bankruptcy or who have an income level that is too low to justify the credit lines that they are given, all receive high-interest credit," Goldstein wrote.
One Amazon commenter went so far as to deny free will with respect to credit cards.

It's hard to get hard data on this subject since I can't seem to find any U.S. Census data on "debt load versus personal responsibility" or "how many bankruptcy victims own 50-inch screen televisions?".

Yahoo Answers tackles the subject, saying it's not either/or but and/both:
With the deregulation of the banking industry...once traditional credit card companies saw the money to be made in the sub-prime market, they started offering "prepaid" credit cards and offering regular credit to people they never would have extended credit to before....

Now, how did consumer behavior change? The change in behavior is linked to a change in generations. The generation that remembered the Great Depression had a tendency to save, simply because of the experiences they had with a severe, and prolonged economic downturn. They knew that a rainy day would come sooner or later, and you needed to save for that eventuality.

That generation has been replaced by a generation that remembers the 1970s stagflation where savings evaporated in the double digit inflation. Also, the younger generation has experienced nothing but steady, growth unimpaired by inflation in the 1990s. These two generations don't save for what they want and keep a nest egg for emergencies. Why would they? They believe, from experience, that jobs will always be available if you have skills and there is no such thing as a rainy day.
That makes a kind of sense. In an ahistorical society we tend to judge everything by our own experience.

No comments: