Escape from the great debt trap

Consumers are making remarkable progress in restoring their credit. That means they can start spending more, something the economy badly needs.


Michael Busick, a Charlotte, N.C., math teacher, says his credit union "was shocked" to discover his credit score was 812 out of a possible 850 when he applied for a $19,500 new-car loan. The loan officer told him he rarely saw scores so close to perfect, says Busick, 33, who added he pays bills on time and doesn't overextend. He got the loan.

The average U.S. credit score -- a predictor of the likelihood that lenders will be paid back -- rose to 696 in May, the highest in at least four years, according to credit-reporting bureau Equifax. Delinquencies on consumer loans have dropped 30% in two years, according to Federal Reserve data.

Improving credit quality gives households the ability to spend more. A rebound in spending would belie Morgan Stanley economist Stephen Roach's claim that consumers will be "zombies" for years because they are saddled with too much debt.


"The financial situation of the household sector has improved far faster than everyone thought it would two years ago," says James W. Paulsen, the chief investment strategist for Wells Capital Management in Minneapolis. "People are still locked into the view that consumers are facing record burdens, and they are not."

U.S. consumers have reduced debt by more than $1 trillion in the 10 quarters ended in March, according to the Federal Reserve Bank of New York. Households spent 16.4% of their earnings on debt payments in the first quarter, including lease and rental payments, homeowners insurance and property taxes. That's down from 18.9% in the third quarter of 2007, before the recession started.

Even consumers in trouble are in better shape, says Mark Cole, the chief operating officer for Atlanta's CredAbility, a nonprofit provider of credit counseling. Clients have an average of $19,500 in unsecured debt this year, down 30% from 2009 and the lowest in at least six years, he says. "We really see credit quality increasing."

Credit card companies notice the rebound, too. Discover's rate of 30-day delinquencies was 2.79% in the second quarter, the lowest in its 25-year history, company officials said in June.

Jennifer Lahotski, 28, who has a marketing job in Los Angeles, says she's been improving her credit since 2007, when her score was "absolutely below 660," the number Equifax says is the minimum needed to qualify for prime consumer loans. The Penn State graduate had been late on some bills and even had an old charge of $5 from a gym.

"I went through each expense, each delinquency, and sent them a check," she says. "I turned myself into a hermit for six months, but I did it," eliminating most restaurant meals and "random Target runs where you come out with $50" of merchandise. Lahotski, who has a Visa and an American Express card and $15,000 in student loans, says she is now saving "a few hundred a month," with plans to buy a house when she can afford a down payment.

While household obligations are at a 17-year low because of increased savings and lower interest rates, Roach, the nonexecutive chairman of Morgan Stanley Asia, calculates that household debt still comes to 115% of income, compared with a 75% average from 1970 to 2000. "We need to encourage balance-sheet repair and adjustment by overly indebted, savings-short consumers," he says.

Roach's view is supported by some economists, who say the debt that fueled the housing boom from 2002 to 2006 will take years to unwind. This deleveraging "is pernicious, it's ongoing and it's holding back growth because people are going to save more and spend less," says Kevin Logan, the chief U.S. economist at HSBC Securities in New York.

Yet other economists see something more nuanced happening: Some consumers are still paying down debt, while others feel financially healthy enough to borrow. A small percentage of senior loan officers reported growth for all consumer lending in the first quarter. That was the first increase since 2005, according to a quarterly Fed survey released in May. About 29% of the loan officers interviewed were more willing to make consumer-installment loans. In the second quarter, loan officers reported a pickup in demand for auto loans.

Dean Maki, the chief U.S. economist at Barclays Capital, says the growth in credit reflects an underlying optimism. As a Fed economist in 2000, he published research that concluded "high debt burdens are not a negative force." He adds, "When consumer credit is growing, it is a sign that households have become more confident about income prospects."

Sometimes that confidence is horribly misplaced, as in the years leading up to the crash. Fortunately, the actual increases in consumer credit today are very modest.

The return to borrowing by some consumers is already benefiting companies. Craig Kennison, an analyst at Robert W. Baird & Co. in Milwaukee, predicts lending profits will rise at CarMax, the largest U.S. seller of used cars, and Harley-Davidson. Their finance arms "have fully recovered," says Kennison.

The shares of credit card and banking companies will benefit, too, says analyst Brian Foran of Nomura Securities International. "Consumers spend money based on their cash flows," he says. "And their cash flows are fine."


Math teacher Busick, who has a home loan and four credit cards, estimates his near-perfect credit score has risen from the upper 700s in the past few years. While he uses an American Express card to accumulate frequent flier miles on Delta Air Lines, he pays it off in full most months. "I don't have late payments," he says. "I pay all my bills on time." Virtue has its rewards.

Now Busick is thinking of buying a Sony television or a Dell or Hewlett-Packard computer that could cost $2,000. "If I want something, I will get it," he says.

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More in debt than Uncle Sam

As Americans ridicule their government for running up huge deficits, household balance sheets are in their worst shape in 80 years. But investment discipline can start to repair the damage.


You may remember J. Wellington Wimpy, more commonly known simply as Wimpy, Popeye's beloved friend from the iconic comic strip. Wimpy was soft-spoken and intelligent, but also cowardly, lazy, stingy and gluttonous. A true scam artist, Wimpy usually finagled his favorite meal, a hamburger, from some unsuspecting patron at the local diner. Wimpy's parsimonious ways included his famous con line, "I'll gladly pay you Tuesday for a hamburger today."

Decades later, this character, created in 1932 during the Great Depression, has become a symbol of fiscal irresponsibility.

Today, the United States is facing its own Wimpy-esque moment in the form of the debt ceiling. The free burgers have flowed for some time now, but the patrons have grown wise to the scam. The pitch of pushing off today's payment until some future Tuesday has become a bit haggard and worn thin for many in America.


Simply look to Greece, Portugal, Spain and other countries to see what it is like to have one's hamburgers taken away. The forced diet does not look pretty.

Strangely, as the U.S. citizenry passionately criticizes its government for running up a budget deficit, a greater irony is afoot: When it comes to debt management, Americans are, sadly, worse than their government.

While government debt sits at 94% of national revenue, U.S. household debt sits at a whopping 107% of personal income.

The household balance sheets of Americans are in worse condition than at any time since the Great Depression. The ratio of household debt to gross domestic product is greater than at any time since 1929. And while we all are trying to comprehend what life will be like as a poorer nation, many Americans have not yet comprehended their own personal poverty.

From the early 1940s through the late 1960s, an ethos of saving before spending ruled the roost. If you sought to buy a house, a 20% down payment was required. Similarly, substantial savings were required to buy a car. Home furnishings, clothing and more were purchased primarily with cash.

By the 1970s, however, rampant inflation helped form a debt culture that found footing and gained steam.
If you saved, inflation threatened to erode the value of your savings, while the price of your desired purchases continued to rise. What was the point of saving when you could buy with little to nothing down, deduct interest from your federal tax obligations and have those things you longed for?

Over the coming decades, American household debt ballooned, eventually doubling from $7 trillion to $14 trillion between 2001 and 2007. Debt fears, however, were assuaged by the rapidly growing value of real estate; homeowners used equity lines to buy more property and cars, as well as pay for vacations and toys. Burgers were flowing for all.

Then in 2008, the sudden and violent decline in home prices revealed just how bad the debt binge had been. Tuesday had finally arrived, and, like Wimpy, our wallets were a bit too thin to meet our obligations.

A renewed focus on government fiscal irresponsibility should lead us to honest self-examination. At the heart of this audit should be confronting personal debt and embracing basic investing disciplines.

Each person must make a decision to feed the debt furnace or build a retirement engine.

Like Wimpy, we all experience the gnawing hunger to consume more than we need. Each time we reach out, through credit, for a burger today, we take our future dollars and throw them into the blazing furnace of consumption. The heat of the moment is delightful, but the result is the poverty that's unfolding before our nation.

When we behave like wise and disciplined investors, we resist our pulsing appetites, take our hard-earned dollars and direct a predetermined portion to smart, long-term investments. In doing so, such investors build an engine through the miraculous power of compounding interest.


Unlike Wimpy and other debtors, this interest works in your favor. Ben Franklin understood that for such savers, "money can beget money, and its offspring can beget more." Albert Einstein called compounding the "eighth wonder of the world."

Those who reject debt and invest wisely create a powerful engine, so that Tuesday's obligations can be fully met on time, leaving a few burgers to spare.

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Using a Debt Snowball

If you're in debt and have multiple credit cards making your life miserable you know how important it is to get out of debt. Unfortunately, when you're juggling a number of debts, big or small, it can seem like an impossible task. That's where the debt snowball comes in. By doing little more than you're doing right now, you can put the debt snowball to work so that you can not only pay off your debt faster, but begin paying off cards completely, which has a huge psychological impact.

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Causes of Falling in Debts

There are a variety of reasons why a person often falls under the burden of overwhelming debts. Out of all, these are the most important causes of falling in debts.

1. One important reason for you to go in debt is when you don’t take care of your daily expenses, the more you spend the little is left for savings and the income decreases because of your expenses.
2. A Monthly spending plan is essential. This will help you to learn where you are spending the money, you should always write down your expanses which will help you to tally with your income. Many a times we spend money unnecessarily writing down will cut down your expenses and help you from any kind of debt. This will also make you feel powerful because you would know where to spend and where not to.
3. Getting married more than once is also one big reason to go in debt, because with new spouse there is always a party, shopping, and honeymoon these are the most expensive things which comes with new wedding which can be breathtaking for your debt cause.
4. Gambling is one of America’s newly born entertainment. Either way you exchange money from home to casino that can also be an addiction which can lead you to your greatest downfall. People at times go to extreme end where they are intoxicated and ready to mortgage their house which can be ridiculous for the family.
5. Well there are other reason like gaps in coverage, lapsed policies this all adds to the debt that you may be in. One of the reasons is also the medical expenses with lapsed policies that means more debt for you. Now days every doctor takes credit card is it convenient? Please think.
6. The simplest way to save you from debt is having savings, Savings of six to seven months of living will always give you a cushion of joy, like in emergency of a job lay off, divorce or illness is not going to cause you an immediate financial strain and increase debt.
7. Shifting jobs from one place to another could be a pain, if you think down the road if you increase your income due to more hours, a second job, or a better job, then is the time to start adding in some of the previous spending before you became underemployed.
8. Always discuss your financial goals with your spouse. If you are married to a spender and you are the saver then it becomes very important to strategies the budget and you should always be aware of yours spouses account, many times you find out that your spouse has used thousands of dollar in credit card which you are not aware of, it can also lead to debt.
9. Never ever spend the money until and unless your check is cleared. Spending tomorrow’s money today is very tempting. This is called banking on a windfall. The things that you may believe will come your way might be very hurting when it does not come your way. The simple philosophy is don’t spend the money until the check clears.
10. Get financially educated because financial mistakes are very expensive and complicated to resolve.   This can also be a biggest reason for you to get in a debt.

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