Consumers who freely piled up debt when interest rates were falling soon could wake up with a financial hangover.
The costs of carrying consumer loans, from home-equity loans to credit cards and auto loans, have been steadily rising ever since the Federal Reserve began its more than yearlong campaign to boost short-term interest rates. Last week, the Fed raised its target rate for the 10th consecutive time, to 3.5 percent, and showed no signs of letting up.
Because rates on most consumer loans are tied to the prime rate -- now 6.5 percent, compared with 4.5 percent a year ago -- average rates have risen alongside the Fed's moves. Home-equity lines of credit, for instance, have risen two percentage points in the past year.
For one, consumers have been feasting off low rates for some time. Overall, U.S. consumers hold nearly $11 trillion in debt, up from $6.8 trillion in 1999, according to the Federal Reserve. To be sure, households' net worth, bolstered by appreciating home prices, also has risen over the period, to about $49 trillion from $42 trillion. The major shift is that consumers are piling up more adjustable-rate debt -- meaning their monthly payments will move in tandem with interest-rate increases.
Consumers may not feel the full squeeze of rising rates for another two or three years, experts say, giving households time to whittle down their debts. Households may start buckling under their debt loads starting next year or in 2007, when many option adjustable-rate mortgages and interest-only loans begin to reset at the higher interest rates.
Let me put these debt figures into historical context.
According to the Federal Reserve, total consumer debt is just under 10 trillion dollars. This includes credit card and mortgage debt. This is the highest level in 25 years.
According to the Federal Reserve, mortgage debt increased from 5 trillion to just under 10 trillion from 2000 - 2004. This is the highest level in 25 years.
According to the Federal Reserve, household debt as a percentage of GDP has increased from 70% to 85% from 2000 - 2004. This is the highest level in 35 years.
According to the Federal Reserve, household debt as a percentage of assets has increased from 15% - 18% from 2000 - 2004. This is the highest level in 40 years.
Also remember that after inflation, wage growth was stagnant for the last few years. This means debt payments are taking a larger percentage of personal income.
America has maintained it's standard of living through debt because wages have not grown in the last 5 years. According to the Bureau of Labor Statistics, the average earnings increase from 2000-2004 was 3.86%, 3.22%, 3.12%, 1.71% and 2.39% respectively. However wages have to be compared to inflation to determine the real rate of wage growth. For the same years, annual inflation was 3.4%, 2.8%, 1.6%, 2.3% and 2.7% respectively. When inflation is subtracted from wages, overall wage growth becomes .46%, .42%, 1.52%, -.59% and-.31% respectively for 2000-2004.
As former Fed Chairman Paul noted: "What holds it all together is a massive and growing flow of capital from abroad, running to more than $2 billion every working day, and growing. There is no sense of strain. As a nation we don't consciously borrow or beg. We aren't even offering attractive interest rates, nor do we have to offer our creditors protection against the risk of a declining dollar."
At the same time, the US savings rate - which has been declining for the last 20 years, has hit 0%. Therefore, consumers have no money set-aside for a "rainy day." This lack of national savings makes the US that much more dependant on foreign inflows of capital. Should foreigners decide the US is no longer a great place to invest, they refusal to fund our debt-spending habits would spike interest rates, starting the spike.
Combine that with the new bankruptcy bill which makes it harder to declare Chapter 7 bankruptcy, and we could quickly become a nation of indentured servants, serving credit card companies, banks and other creditors.
Let me sum up. The US is in debt up to its eyeballs. We have no savings. The only thing keeping the economy together at the macro-level is the kindness of foreign investors. Should they stop investing heavily in the US, the dollar will start to drop. The Fed will be forced to hike interest rates to protect the dollar in the forex markets. The massive national debt load will become far more expensive to maintain.
Volcker's Statements
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