October 13, 2008
Middle class is mired in debt Simple misfortunes make bills pile up quickly BY JOHN GALLAGHER FREE PRESS BUSINESS WRITER What does bankrupt Detroit-area auto mechanic Ernie Berthet have in common with Wall Street? Both have been humbled by bad debt, the thread that ties the economic struggles of ordinary Americans to the once-venerable financial houses brought to their knees in recent weeks. It was Berthet's mortgage foreclosure, multiplied by at least a million other bad home loans across the country, that rocked America's financial system and moved the nation toward the biggest business rescue plan in history. The numbers on Wall Street are dizzyingly large. But brought down to the level of just one distressed borrower, the story shows how even modest levels of debt, if made unmanageable by a layoff, divorce, illness or other hardship, can turn tragic. Like a lot of bankruptcy filers, Berthet, a 51-year-old Dearborn Heights resident, saw his problems mount not from a profligate lifestyle but from simple misfortune linked with perhaps too-easy credit. His modest, one-story house in a working-class area cost $82,000. He had a zero-down, adjustable-rate mortgage that reset from 7.35% to 10.35% and then to 13.35%. Losing his job and owing child-care payments to his former wife put him in the red. "I'm a mechanic by trade," he says. "I was a contract worker, worked in a couple different dealerships. It seems like I'd just get caught up, got all kinds of overtime, and then -- boom! -- we got laid off," he says. Unable to pay his bills, Berthet filed for bankruptcy and gave up his house in foreclosure this summer. "The way the state of the economy was, when I bought my home, I planned on living in my home until I died, but the times they are a-changin'," Berthet says. The problems on Wall Street and those facing Main Street thus are twisted together in a pervasive tangle. If Wall Street's problems are getting most of the headlines now, debt problems for most of this decade have been posing a large and growing challenge to maintaining a traditional middle-class standard of living for ordinary Americans. Today, debt pervades all aspects of American life: The average household now holds more than $110,000 in mortgage and other debt, against annual personal savings of around $400, according to figures from the Federal Reserve Board and other government bodies that track the economy. American consumers today collectively owe $2.5 trillion on their credit cards and in car payments and similar loans. That's up 150% from 1994, an increase more than four times greater than inflation over the same time. New college graduates carry more student-loan debt than ever. The nonprofit Project on Student Debt reports that by the time they graduate, nearly two-thirds of students at four-year colleges and universities have student loan debt, compared with less than one-half of graduating students in 1993. Over the past decade, debt levels for graduating seniors with student loans more than doubled from $9,250 to $19,200 -- a 108% increase, or 58% after accounting for inflation -- the project reports. Student loan load Scott Howland, a 2003 graduate of the University of Michigan, has a common debt story at age 28. A ticket office manager for Palace Sports & Entertainment, Howland graduated with $22,000 in student loan debt, has a $150,000 mortgage on his house in Madison Heights and owes $5,000 on credit cards. He's getting married soon and plans to help pay his fiancée's credit-card balance of around $15,000. He says his student loans require a minimum monthly payment of $138, which he has automatically withdrawn from his savings. "For a while there I was trying to pay a little bit more every month, get more on the principal, trying to almost pay double sometimes, but then other expenses crept up and it got to the point where I can only pay the minimum on this and I need to focus my money on the other debts," he says. The nation's debt burden has soared since the late 1990s, much of it tied to the bubble in housing prices between 2000 and 2005. Americans added about $1 trillion in new mortgage debt -- including home equity debt -- per year since 2000, and many families borrowed still more on credit cards. When home prices collapsed, much of that new accumulated debt could no longer be supported and homes couldn't be sold, at least for what was owed on them. But by then, Americans owed more than they made. Since 2002, debt has exceeded disposable income in America by an ever-growing margin. In 1990, debt equaled 78% of disposable income; as of 2007, the figure was 129%. Types of credit unknown 20 years ago, such as home-equity loans and borrowing against 401(k) retirement accounts, have sapped long-term savings. Home equity loans became a popular way to borrow against the value of a home in the mid-'90s, and since 1998, such debt in the United States has soared from about $300 billion to more than $1.1 trillion. Since early 2007, homeowners owe more on their houses than they hold in equity. Americans now hold as equity 46.2% of their home values. That's down from 57% in 2001, and represents the first time since World War II that equity levels have shrunk so low. Stephen J. Church, an investment consultant who heads Piscataqua Research Inc. in Portsmouth, N.H., says some retrenchment in the way Americans live is inevitable. Before 1990, he says, Americans spent about 80% of their incomes on goods and services, paid debt with about 10%, and used the rest for savings or discretionary spending. By 2006, Americans were spending nearly 90% on consumption and 13% to cover debt, meaning they had to borrow just to maintain their lifestyle. "Basically, we had a strong economy built on a mirage of borrowing. It is right there in the numbers," Church says. As a result, more and more Americans are facing a significantly bigger burden each month trying to pay down mortgages, credit cards and other types of debt. The U.S. Census Bureau reported last month that 37.5% of American households now spend more than the traditionally safe 30% of income on housing. American living standards, which through the country's history have promised an ever-improving way of life for each new generation, already were under threat as middle-class incomes stagnated. Adjusted for inflation, middle-class households earn about $400 less today than they did in 1999, the Census Bureau reports. Now the borrowing spree of the past decade threatens to make that problem a lot worse. With personal consumption accounting for 70% of the U.S. economy, any cutting back to pay down this mountain of debt threatens a slowdown for the economy -- and a further lowering of standards of living for millions of Americans. Wake-up call Ann Howard, a bankruptcy attorney from Southfield, says the lesson of recent financial woes is simple: The party's over. "I think it's been a real wake-up call for everybody because you just can't assume that you're always going to make what you're making now or what you made two years ago," Howard says. "You have to keep your expenses low enough so you can ride through the storm if there is one." Responsible debt, of course, will remain an integral part of financial life in America, with borrowed money paying for everything from cars and homes to complex corporate deals. "I don't want to create the wrong impression that all debt is bad debt," says economist Jared Bernstein of the Washington, D.C.-based think tank Economic Policy Institute, noting that many families borrow for college education and other productive uses. But he adds that many struggling families borrowed not for long-term goals but simply to keep up, especially as paychecks lost ground to inflation. "In many ways, lots of middle-income families compensated for their lack of good, old-fashioned income growth by taking on more debt," Bernstein says. With Americans borrowing and spending so freely, they were saving less than ever, government data show. Personal savings as a percentage of disposable income has dwindled to less than 1% today from nearly 8% in the early 1990s. With incomes stagnating and using debt to keep up, many Americans placed themselves in a position where any unexpected setback could send household finances into a tailspin. "We all know that the expenses that really hurt you financially aren't necessarily the predictable ones," Howard says. "Obviously gas and food have gone crazy, but you have the transmission that goes or the $1,200 deductible on your health insurance when your kid has an appendix rupture." Credit card crunch Veronica Smith, a debt counselor with the nonprofit GreenPath Debt Solutions office in Roseville, says it's common for people who come to her office to have credit card debt equal to a year's salary at a job they lost. Howard agrees. "It's a very predictable pattern," she says. "You're going along and then somebody loses a job or somebody has surgery or someone loses their overtime, but you still have all your typical expenses that your income went to. So what do you do? You prop up your household with credit cards and you do that as long as you can." Howard adds that debt-fueled problems are moving up the income chain. "I'm seeing a different kind of client now than I've seen before. It's hitting the upper middle class," she says. One client, a real estate professional, saw his annual earnings drop from more than $200,000 a couple of years ago to less than $15,000 today, Howard says. The consumer advocacy Web site www.cardratings.com reports that there are now more than 600 million credit cards in circulation, with the average American carrying four cards. About 60% of cardholders carry over a balance from month to month, often totaling in the thousands of dollars. This debt has helped generate billions of dollars in profits for the credit-card industry, and every dollar of that ultimately came out of consumers' pockets. The psychic toll on Americans who see their lives disrupted by excess debt can be enormous, Howard says. "They're overwhelmed, they're completely stressed out, they're depressed, they're tired," she says of clients who come to her office. Contact JOHN GALLAGHER at 313-222-5173 or gallagher @freepress .com. http://www.freep.com/article/20081013/BUSINESS07/810130384 This message has been scanned for malware by SurfControl plc. www.surfcontrol.com _______________________________________________ pen-l mailing list [email protected] https://lists.csuchico.edu/mailman/listinfo/pen-l
