Into the Whirlwind: The Impact of American Indebtedness

Five factors have contributed to consumer bankruptcy: job and income loss, sickness and injury, divorce, homeownership, and too much credit. The first four of these are the necessary preconditions to increasing financial failure, and frequently the triggering causes, but they are not sufficient in themselves to explain a 300 percent increase in bankruptcy filings since 1984. 8 Consumer debts are the additional explanation for the increase in economic distress that leads to bankruptcy. Stuart Feldstein, a senior analyst at SMR Research of Hackettstown, NJ, said that to grasp the awesome meaning of our dependence on consumer debt one has to look at a very big number: $8.199 trillion - more than $80,000 for every household. 9 That includes mortgage debt, revolving debt, auto loans and student loans, among other categories. That doesn't include things like utility bills, groceries or car insurance. Even more revealing is how much more debt we could acquire, thanks to the ease with which Americans can expand their credit limits.

Who are these debtors? How similar are they to one another? How similar are they to those who are not in bankruptcy? These are questions that are addressed in a study entitled The Fragile Middle Class. In this study the authors conclude that bankruptcy is a middle-class phenomenon. Generally speaking, these debtors are very similar to their neighbors. They come from all ethnic backgrounds, and all occupations. They have in common a terrible financial condition, and from the 1980's on have been increasingly white-collar workers. 7

The federal government is partially to blame here. The guidelines for obtaining a home loan have become looser and looser over the years. For example, a buyer can obtain an FHA loan one year after filing a Chapter 13 bankruptcy. Under FHA guidelines, he can have a debt/income ratio of 41%, a credit score of 520 (out of a possible 900), have been employed for only one year, and have as little as 3% down-payment. Is it any wonder some people become homeowners before they are financial capable, and then struggle with the payments? 13 In 2000, one-sixth of all borrowers made less than a 5% down payment on their home loan. To date, the slowing economy has taken only a modest toll on the nearly $5.3 trillion in outstanding mortgage debt. But these new, affordable mortgage products haven't really been stress-tested by an economic downturn. 14 If home prices take a fall, homeowners could find themselves going under with mortgage debt exceeding the value of their homes. This happened on the East Coast and in California in the late 1980's and early 1990's.

As wages became more polarized in the 1980's and 1990's, some observers during this time commented on the shrinking middle-class. To others it appeared that not much seemed to change, as families continued to spend. In reality, the American middle class was running hard to stay in place.

The prolonged low (and now negative) savings rate in the United States has made sustained foreign borrowing necessary to keep the spending boom going. The United States is already one of the world's biggest foreign debtors; 19 this is risky, and the economy will fall if foreigners' appetite for dollars dries up. In addition, all of this borrowing has been on the back of rising asset values. The problem with that is that assets can only pay the interest on loans if they are sold, and this presumes that the value of these assets will either remain stable or increase. It also presumes that these assets were valued correctly in the first place - which is not necessarily a safe assumption. The quality of loan portfolios has declined in recent years, as intens

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