Whither the Life-Cycle? Middle-Class Families Struggling With Financial Distress

Robert D. Manning, September/October 2005

‘There has been a profound transformation in how Americans define needs and wants’

Robert D. Manning

8 In their provocative article, Elizabeth Warren and Amelia Warren Tyagi challenge prevailing assumptions about the unprecedented rise in U.S. household debt. Americans, they argue, have changed little in their traditional preference for providing a basic material standard of living for their families and, in particular, providing economic security for their children through high-quality education, health care, transportation, and other essential needs. Parents today behave much like parents past: they respond rationally to the changing costs of middle-class essentials—even if that now entails assuming unprecedented levels of debt.

While this focus on rising costs illuminates certain aspects of the problem of consumer debt, it also oversimplifies the causes and consequences of such debt. I propose here to explore some of these complicating factors.

Individuals commonly accumulate their highest levels of debt at the beginning and middle stages of their careers, due to educational debt and low salaries or wages. Households also accumulate a large amount of consumer debt during their early stages because this is when many people purchase a home and have children; the cost of this latter choice is increased if a mother temporarily withdraws from the labor market in order to care for young children. Traditionally, then, households pay off their debts and start saving and investing as their incomes increase. As families fulfill their obligation of providing for their children, they are assumed to accumulate the bulk of their household wealth in the last decades of their careers and to augment their savings through intergenerational wealth transfers. Warren and Tyagi do not consider such life-cycle patterns, and a common critique of the over-indebtedness argument is that its analysis typically focuses on specific points in time rather than on the entire life course of individuals and households.

One of the benefits of a life-cycle analysis is that it helps us to distinguish household dynamics from behaviors and experiences that vary across historical periods (cohort effects). In a recent study on the changing cognitive attitudes and behaviors of American households, I examined the experiences of six different life-cycle groups (college students, young singles, young families, mature families, empty nesters, and seniors), and found that the commitment to saving has fallen from previous generations. Two key factors in this change merit attention.

First, while the oldest age cohorts (empty nesters and seniors) still embrace self-discipline, pursue saving over debt, and share an aversion to debt-based consumption, their children and grandchildren are less wedded to such traditional values. The unrelenting financial demands of younger family members result in intergenerational wealth transfers at earlier stages, and, together with the sharp increase in the costs of elder medical care, this dramatically shrinks the nest egg that most middle-class seniors are able to pass along at the ends of their lives.

Second, these shifting views about saving and debt reflect a profound transformation over the past 30 years in Americans’ definition of “needs” versus “wants.” For example, parents now see costly extracurricular activities as needs, essential to creating opportunities for their children: ballet lessons, musical instruments, scout uniforms, tutoring, summer camps. Admittedly, many of these expenses reflect the underfunding of public institutions. Nevertheless, in my research I found that many parents were spending on their children’s “socially required” high-school activities instead of saving for their children’s college educations—a major contributor to the soaring debt levels of recent college graduates. Furthermore, I found that younger cohorts perceive credit as a social entitlement to support their lifestyles, whereas earlier generations viewed consumer credit as an earned privilege that assisted in providing for their household needs. The resulting modern view of “responsible” budgeting sharply departs from traditional attitudes and behaviors: it emphasizes minimum monthly payments and no savings.

The most intriguing example of the cognitive change toward saving and debt is the simultaneous pursuit of both. Traditionally, American families began to invest after first paying off their consumer debt, with the exception of their home mortgage and possibly their auto loans. Today, Americans are investing in their IRAs or 401(k)s long before they have even accumulated any net assets. This change is underscored by the confounding attitudes toward home ownership. Invariably, among both young and mature families, housing is primarily seen as an investment rather than as a marker of security. Most people, however, are unaware of how much price appreciation is necessary for a profitable housing investment after adding the costs of finance charges, realtor and closing fees, taxes, insurance, and maintenance. For many families, the decision to spend more on housing rather than diversify their investment portfolio (stocks, bonds, mutual funds, rental properties) will intensify the pressure to save a much higher proportion of their income at the later stages of their work careers. Significantly, this situation makes them more likely to become even more reliant on consumer credit, which suggests that they will eventually retire with high levels of debt.

Another factor complicating the story of consumer debt—albeit one that Warren and Tyagi address in more detail elsewhere—concerns the impact of post-1980 banking deregulation on the supply of consumer finance. Warren and Tyagi imply that banks simply serve to satisfy family lifestyle demands by extending new forms of consumer credit. In reality, U.S. banks faced a profitability crisis in the early 1980s that led to a rapid shift from corporate and wholesale lending to consumer (retail) lending. As banks developed new loan products, such as revolving loans (e.g., credit cards) and home-equity loans, they aggressively sought new clients who were willing to assume higher debt levels as well as high fees and interest rates. As traditional bank underwriting standards have been reduced, consumers have been deluged with loan offers—secured (refinancings, home equity), installment (auto), and unsecured (credit cards). Currently, the high profitability of consumer lending essentially subsidizes underperforming bank divisions, which in turn intensifies institutional pressures to find new clients and to raise the cost of borrowing.

Since deregulation there has been a dramatic consolidation of the consumer financial services industry and a subsequent decline of the community banking system; the latter, with its risk-averse lending policies, had served as an institutional constraint to high levels of household debt. As a result, the difficulty of increasing a family’s income is obscured by the ease of obtaining consumer loans. This has not only precipitated recent household-debt-consolidation frenzies through home equity and refinancings (which mask the sources of family indebtedness), but also the increase in the total cost of debt service, as adjustable rate loans (mortgages, home equity, credit cards) begin to climb in accordance with rising Federal Reserve interest rates. Not incidentally, the most financially distressed households have become dependent upon leases (e.g., automobile) and usurious loans that are not recorded as debts by the U.S. government (payday loans, rent-to-own contracts).

The causal factors underlying the rising economic distress of the middle class merit brief mention. Although Warren and Tyagi focus on domestic policy and the American family as their primary analytical unit, the reality is much more complex today than it was in the 1950s and 1960s. Globalization and the neoliberal trade regime have intensified pressure throughout American society to promote consumption over savings. American consumption levels must increase in order to sustain the ever-growing volume of international “free trade,” even as the global production of cheaper goods and services puts downward pressure on U.S. wages and services. Increasing household reliance on cheap imported products has ultimately exacerbated the financial distress of American families and relocated a higher proportion of the world’s middle classes from the United States to developing societies such as India, Brazil, and Eastern Europe. This has led some observers to assert that the fastest-growing U.S. export is American-style consumer debt. (Notably, the United States is the only Western industrialized country that has deregulated its consumer financial services industry and tightened its consumer bankruptcy laws. Canada, the United Kingdom, France, and even Australia have all liberalized their debt-forgiveness statutes.)

Soaring levels of U.S. consumer debt cannot, then, be explained simply as the product of voracious American consumers, nor by intransigent structural economic factors that underlie increasing social inequality. Rather, both perspectives offer instructive insights. But a crucial part of the story is the drama of social and economic mobility that pits generation against generation and neighbor against neighbor in a competition that has increasingly assumed materialist dimensions. The reality for most Americans is growing economic insecurity. As global forces continue to shape American industry and economic inequality, my grave concern is that the discussion of consumer debt may understate these forces’ most deleterious long-term consequences and thus postpone the formulation of desperately needed public-policy initiatives addressing inadequate health care, underfunded public education, and the impending retirement crisis. <

Robert D. Manning is a professor of finance at Rocheste rInstitute of Technology and the author of Credit Card Nation and the forthcoming Give Yourself Credit His Web site is http://www.creditcardnation.com.


This story ran on on September/October 2005.