Household finances aren’t weathering economic storm

By John Cunniff The Associated Press
Sunday March 25, 2001

The financial report card of American households is not good as they deal with the first substantial economic slowdown in nearly a decade. Already deep in debt, many may be forced to borrow even more. 

As 2000 ended, outstanding household debt actually exceeded disposable income by $100 billion, putting the debt-to-income percentage at 101.2, compared with just 87 percent in 1990. 

The situation poses problems for families and the economy, especially if jobs are lost. Existing strains also may be worsened if the value of collateral assets, such as homes and stocks, suffer in the slowdown. 

As debts rose during the best of financial times, economists justified the borrowing as safe because of the concurrent rise in the value of assets. But some of those assets may themselves have been inflated. 

The figures are from a review and analysis of Federal Reserve data by the Financial Markets Center, a think tank based in Philomont, Va. It shows that as the expansion faltered, debts grew in the domestic economy. 

In all, as the economy slowed to a 1.1 percent annual growth rate in the fourth quarter, household debt rose 8.2 percent, business obligations by 8.4 percent and state and local government indebtedness by 4.8 percent. Federal government debt fell 9.6 percent thanks to budget surpluses. 

The rise of debt without a spurt in economic activity, said economist Jane D’Arista, the report’s author, “suggests borrowers used some of the additional debt to consolidate and service outstanding obligations.” 

Such behavior underscores the fragile situation facing the Federal Reserve in guiding the economy through the slowdown with careful cuts in lending rates that, among other things, would make debt repayments easier. 

At the same time, it has indicated that the possibility of inflation atop the already tenuous economic situation still exists, and that overly deep interest rate cuts might reignite demand and lead to price increases. 

Meanwhile, three half-percentage point interest rate cuts in less than three months have lessened the strain on many household budgets. 

Home mortgage rates have fallen, allowing many families to refinance and cut monthly payments by $100 or more. Credit card issuers are likely to lower rates. And some retailers may even eliminate interest charges. 

But the answer to whether or not the economy averts the worst of the possibilities is likely to be found in the mind of the consumer. 

The income rise and investment gains in the expansion presented households with the chance to lower existing debts, but they chose to spend and borrow. 

The questions now are: 

1. Have they learned a lesson and will they now try to reach a balance between income and outgo? 

2. Will they instead withdraw from credit markets and prolong the downturn? 

3. Will the Federal Reserve be able to read the signals correctly and keep supply and demand at a happy balance between overpessimism and overoptimism? 

John Cunniff is a business analyst for The Associated Press