Are We Better Off Today?

Aleksandra Todorova, January 31, 2006

Are We Better Off Today?

By Aleksandra Todorova
January 31, 2006

AT 46 YEARS OLD, J. Roberts seems to have it all. Together, he and his wife earn $165,000 a year. With their two children, they live in a 2,835-square-foot, four-bedroom, three-bathroom home in an upscale Dallas suburb, complete with marble floors, a state-of-the-art kitchen, two living rooms and a pool in the backyard. Three cars -- a 2001 Ford Explorer SUV, a 2003 Volkswagen GTI and a 2005 Mini Cooper -- are parked in the garage.

Yet, Roberts -- whose name we've changed to respect his privacy -- feels far from the American dream. He and his wife have accumulated more than $50,000 in credit-card debt over the past 20 years, most of it a "hangover" from their early years together when money was tight. That debt, combined with their everyday expenses, like the upkeep of their home (which has $50,000 in equity), leaves little left over for long-term goals like saving for retirement. Right now, the Roberts' retirement savings barely reaches $15,000. And paying off those credit-card bills -- at a time when one child is in college and the other a high-school junior -- seems downright impossible.

The Robertses are not alone. Across the country, today's families are burdened with debt, struggling with mortgage payments and saving next to nothing. It's a trend that has grown steadily over the past two decades, thanks in part to the low interest rates welcomed during the Alan Greenspan era.

Greenspan, who steps down today as Federal Reserve chairman, has been credited for deftly leading the nation's economy through two recessions that may have been much uglier without his bold and well-timed interest-rate slashes. And overall, the economy has experienced unprecedented growth during his reign: Among other things, home ownership is at a record high, while unemployment and inflation remain low.

But some economists and consumer experts say that Greenspan's financial maneuverings could cause serious side effects for consumers over the next decade. "Greenspan was able to significantly expand consumption based on debt in America," says Robert Manning, professor of finance at the Rochester Institute of Technology and author of Living With Debt1, a 2005 report on consumer attitudes toward debt. "It's true that consumer credit has tremendously elevated people's lifestyle, and they've enjoyed a lifestyle they couldn't ordinarily have had. But at what cost? These are people who aren't going to be able to retire the way they're living today."

Truth is, when you look at the numbers on housing, debt and income levels over the past few decades, you'll find Americans aren't much better off today than they were 20 years ago, two years before Greenspan took office. In many respects, they're actually doing worse.

Deeper Into Debt
It's no secret that debt levels have ballooned over the past 20 years, from $124.4 billion in revolving debt in 1985 to nearly $800 billion in 2005, according to the Federal Reserve. The average American household currently owes $8,650 on their credit cards, according to the latest survey on consumer debt by Demos, a New York-based economic research and advocacy group.

And much of that debt has been accrued covering everyday items. Seven out of 10 households reported using their credit cards to pay for car repairs, basic living expenses or house repairs, in effect using debt as their "safety net," according to that same study. One out of three families reported using credit cards to cover basic living expenses for on average four of the last 12 months.

It's not surprising then that Americans today aren't saving anything -- anything at all. In fact, for the first time since the Great Depression years of 1932 and 1933, the personal savings rate dropped below 0% (to -0.5%) in 2005. Translation? Americans were spending more than they earned, either dipping into savings or falling deeper in debt.
A House of Cards?
One exceedingly bright spot in the economy has, of course, been the hot housing market. Over the past five years, home prices have soared an average 55% across the country, according to the Mortgage Bankers Association. For many homeowners, that's created cash windfalls.

Much of that new equity has been tapped, however, as Americans have taken advantage of low home-equity loans and line-of-credit rates to pay off credit-card debt, foot the bill for family vacations or fund home improvements.

According to Demos, the average American homeowner's equity has fallen from 68.3% in 1973 to 55% in 2004. While that shouldn't be a problem if home values keep appreciating, should the market head down or remain flat -- as some economists predict -- homeowners could find themselves owing more to their lenders than their homes are worth.

And home buyers are now borrowing more to buy their homes. In the first half of 2005, a full 23% of the dollar volume of new mortgage originations was attributed to interest-only loans, according to the Mortgage Bankers Association. Another 7% were payment-option adjustable-rate mortgages, or ARMs, through which borrowers have the option to make less-than-interest-only payments, thus negatively amortizing their loans.

Twenty years ago, these products' share was so tiny on the market, "it was an asterisk," says Michael Frantantoni, senior director of single-family research and economics at the MBA. Typically, they were used as investment-planning tools by the wealthiest households, freeing up, for instance, cash flow to invest in the stock market for better returns.

Needless to say, these mortgages carry huge risk for homeowners who may not be able to afford the significantly larger mortgage payments due several years from now. "It's true there are a lot more innovative products out there that have enabled young people who can't save up for a 20% down payment to get into homeownership," says Tamara Draut, director of the Economic Opportunity Program at Demos. "The problem is their status of a homeowner is a lot more fragile."

Vanishing Earnings
Over the past 20 years, the average household income has increased a mere 1.22% annually, from $47,518 in 1984 to $60,528 in 2004 (in 2004 dollars), according to the U.S. Census Bureau. At the same time, many Americans are shouldering new costs -- like retirement planning and health care.

"Productivity has been on the rise, but that gain in productivity isn't going to workers," says Draut. "Incomes are stagnating, costs are continuing to outpace inflation, whether it's housing costs, energy costs or higher-education costs." As a result, Americans have been turning to credit cards to pay the bills -- and then to their home equity to pay off the credit cards. Going forward, Draut says, consumers' only option is to reduce spending. "There's no more equity left to tap, credit-card debt keeps going up, and wages aren't growing," she says.

That's exactly what Roberts plans to do. He is thinking about moving his family into a smaller home, located in a still underdeveloped area about 30 miles further out of the city than where they live now. "Moving out to the boonies is not a pleasing thought," Roberts says, especially since the increase in home prices means they'll need to take out roughly the same mortgage as they owe on their current one to buy a smaller home. But it may be the family's only way out of the financial rut.

Links in this article:

URL for this article:


This story ran on on January 31, 2006.