By: Roshawn Watson
In the first quarter of 2008, our debt to disposable income peaked at a staggering 131%. This means for every dollar we earned, we spent $1.31. As of March, our debt as a share of our annual income is presently 122%. If you think this change indicates that we have collectively been so scarred by the "Great Recession" that we are now behaving fiscally responsible, think again. There is a surprising and sad reason why our debt has gone down. Hint, it has nothing to do with frugality.
We Have A Debt Problem
With the macroeconomic issues, such as unemployment and recession(s), dominating the headlines, it is easy to forget that we have a culture of debt. Debt is so ingrained into our lives, it's almost like we have a love affair with debt.
We barely even think of the true costs of our purchases anymore. We often don't ask "how much our purchases really costs" but rather "what is the payment?" The difference between those two statements is enormous although not intuitively obvious. While the former question is concerned with the overall and long-term financial implications of the purchase, the latter focuses on how can I get "it" now. Such shortsightedness can be financially disastrous.
David Wilding said it best...
Whenever I hear the phrase “more affordable", I put my hand on my wallet because the attempt to empty it will begin any moment. Almost never is that phrase used in relation to the total cost of financing. It is always used in reference to the size of the monthly payment.In other words, this increase in affordability is achieved by prolonging our indebtedness. By spending tomorrow's income today, we have simultaneously increased our financial risks, decreased our ability to build wealth, and probably overpaid. For example, when I purchased my first car, I was able to negotiate the price down nearly 40% because I was a cash buyer. Research shows that I'm not alone, Dunn and Bradstreet demonstrated that we spend 12-18% more when we pay by credit compared with cash.
We are permissive to debt because it is the most aggressively marketed product in our culture. By convincing us that debt is okay, marketers both decrease our inhibition to make a purchase and indirectly encourage us to spend at least 12-18% more. Make no mistake: marketers spend billions of dollars to make sure that we concentrate on payments instead of the total costs. Unfortunately, all of this marketing has worked well because we constantly buy things that we can't afford. For example, it is quite common for us to drive cars that we really can't afford (of course we afford the payments just fine). The cost of maintaining a car payment long-term can be measured in the millions, even if you use conservative estimates. For example, the average car payment in North America is $479 monthly. If you invested that car payment from age 25 to age 65, you would have over $2,000,000 (assuming a 9% return). It's no wonder why finance companies want you to focus only on the short-term implications of a payments rather than the long-term impact to your overall wealth. That car in your drive way could be keeping you from becoming a millionaire! Additionally, your car payment (your liability) is their asset and is making them rich while you stay broke. Of course, we're not just over-extended when it comes to cars. Even our housing can be at least somewhat out of control. Some 40% of homeowners are over-extended. On average, 15% of homeowners are spending at least 50% of their income on housing costs. This is a big losing battle because it is nearly impossible to get ahead financially with such huge housing expenses. It's recommended that we spend no more than 28% of our pretax income on housing (including insurance and taxes). Of course, credit cards, student loans, and other private loans often are even a bigger problem than housing for most people.
Falling Debt Burden
The point is it is perhaps overly optimistic and naive to think that all of this changed, even with a deep recession. We have simply drunk too much of the "a little debt is alright" kool aid. Thus, with that context, it shouldn't come as a revelation that the real reason for the debt decline has little to do with us tightening our belts. Instead, people are making much more progress eliminating their debts by simply defaulting on mortgages and reneging on credit cards.
Some of you indicated that I was being a little to harsh a few weeks ago when we discussed
how savings had decreased while spending increased, perhaps this latest data will convince you that we haven't mended our ways. Mark Whitehouse from WSJ argues:
Despite our proclamations of frugality and austerity, old habits die hard and our actions speak way louder than words. Those actions are our savings decreased, our spending increased, our indebtedness increased or we simply defaulted on our debt and asked for someone else to foot the bill. Now if one is part of the 10% who is unemployed, then it is not surprising that things are not going well financially; he or she has an income crisis, which is a different matter entirely. However, it's the misbehavior of the other 90% that's really concerning. The real question is whether or not we learned anything from this financial mess? If the answer is no, then an old forewarning comes to mind.Since household debt hit its peak in early 2008, banks have charged off a total of about $210 billion in mortgage and consumer loans, including credit cards. If one assumes that investors suffered at least that much in losses on similar loans that banks packaged and sold as securities (a very conservative assumption), then the total — that is, the amount of debt consumers shed through defaults — comes to much more than $400 billion.
Problem is, that’s more than the concurrent decrease in household debts, which amounts to only $372 billion, according to the Federal Reserve. That means consumers, on average, aren’t paying down their debts at all. Rather, the defaulters account for the whole decline, while the rest have actually been building up more debt straight through the worst financial crisis and recession in decades.
Those who ignore history are doomed to repeat it.
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