3:40 pm
Tue March 2, 2004

Plastic Money

Younger generations are not as debt-adverse as their parents and grand-parents. A fact which has some economists calling for changes in the ways credit is offered.

Wilmington NC – [Click the LISTEN button to hear Dennis' commentary.]

Consumer debt is at an all-time high. It is causing some economists to worry that, when interest rates rise ? as they will at some point ? many will be caught in a debt bind. How significant is this debt problem, and does it pose a risk to the nation?s banking system, as well as to many families?

The Federal Reserve recently reported that outstanding consumer debt, excluding mortgages, now for the first time exceeds 2 trillion dollars. This averages about 17 thousand dollars per household. Credit cards account for more than one-third. The number of credit card accounts that are delinquent is at an all-time high ? more than four percent of all such accounts.

Providing further evidence that many are besieged by debt, personal bankruptcies reached a record 1.6 million in 2003. One prominent economist, long been concerned about growth in household debt, recently warned, ?It would appear that people are living on the edge.?

Some are. Enough that change in credit practices is called for. But probably not enough to seriously threaten the foundations of our financial system.

As one presidential hopeful put it, there are two Americas. This certainly is true regarding debt. About 40 percent of all credit card holders pay their bills in full each month. They are doing very well ? earning free airline miles and other goodies. The other 60 percent are, to varying degrees, accumulating credit card debt. Some are swamped.

Stories abound of people over their head in debt. Much of this is credit card debt. As individual financial fortunes decline, credit card payments often are reduced to the minimum, then payments are missed and the situation deteriorates rapidly. Sometimes balances are transferred to new accounts ? solicitations arrive with regularity ? then the new accounts fall behind.

To compound matters, as payments fall behind, interest rates on most accounts climb, digging the hole of debt ever deeper. Even though, overall, interest rates are low, the average credit card carries 15 percent interest. This can quickly jump to 20 or 25 percent for those who fall behind, plus penalties.

Many with serious debt problems are in low income brackets and often have recently experienced a traumatic event such as divorce, loss of job, or serious medical problem. Desperate, they turn to credit simply to get by. For the more affluent, managing credit presents fewer difficulties. Delinquency rates have actually declined on loans for things such as boats and recreational vehicles that are typically purchased by those with higher income. By contrast, delinquencies on mobile home loans have increased.

The problem is amplified by the easy availability of credit. Last year, 5 billion credit card offers were mailed out in the US, including many to consumers who would not have qualified for credit a few years ago. Quite simply, despite delinquencies, banks are generating good profits on credit cards, reflecting a wide gap between low interest paid on savings accounts and high interest received on credit card loans.

Compounding this is a cultural shift to a generation of Americans who accept debt as a way of life. By contrast, earlier generations, who were closer to the Great Depression, tended to be more debt adverse.

With roughly 95 percent of households paying credit card obligations as agreed, there is little immediate threat to financial institutions from delinquencies. Last year, only two commercial banks in the US failed. But, a significant jump in interest rates could push many more households over the edge ? particularly those who are already having trouble making minimum payments. For sure, credit cards provide consumers with both convenience and a way to deal with financial exigency. Even so, it seems past time for banks to rein-in credit card solicitations, and to exercise more discretion when extending new credit.