Consumer debt: Economy coup de grace?

Even with the stock market in the tank for months and the economy grinding to a halt, consumers didn’t seem to be getting the message. In fact, consumer spending was one of the few things keeping hopes alive that the economy would avoid a prolonged downturn.

But now it looks like those hopes may be dashed, and we’re going to get a recession whether we want one or not.

That’s because behind all that spending lies a dirty little secret: Consumers are in hock up to their ears.

Now some economists believe the economy’s coup de grace will come from a lurking debt bomb that’s ready to explode and trigger the dreaded downturn we’ve all feared.

Of course, there’s nothing new about debt per se. Americans have always preferred spending to saving. Those spendthrift ways would likely continue as long as consumers had faith in the future.

And through the first two months of the year, that faith seemed undiminished.

Consumer debt rose by $16 billion in January – an annualized growth rate of 12.5% – to a record $1.5 trillion, including the largest increase in credit card debt since August.

In February, consumers borrowed and spent as if there were no tomorrow. Credit card debt jumped by $11 billion – an annualized growth rate of 19.9% – nearly double the amount in January, marking the biggest one-month gain since 1995.

But last week, new figures showed that their faith finally might have been shaken.

Amid the spending spree, default rates on auto and home-equity loans rose while borrowing for big-ticket items such as cars slowed in March compared with January and February.

Unemployment claims edged up as well, reaching the highest level in five years as seemingly one company after another announced a new round of belt-tightening that included layoffs.

The University of Michigan’s latest survey of consumer sentiment also showed growing concerns about the economy. The index fell to 87.8 in April, below analysts’ expectations and down from 91.5 in March.

Retail sales also fell in March after posting slight increases in January and February.

So just how deep is the hole that consumers have dug?

According to published reports, consumer debt – now 70% of the gross domestic product – is at an all-time high, and up by almost 50% over that of the 1980s. As a percentage of personal income, debt has risen to 85%, also an all-time high.

Even more troubling, since July, consumers have been spending more than they’ve had available in disposable income. The savings rate continued in negative territory through the first two months of this year.

According to Monster.com, a career and employment website, nearly two-thirds of those who participated in a recent informal survey said that they were deeply in debt. Of those, 26% said they had “mountains of debt” and could barely pay their bills, and 36% said they were heavily in debt.

If that’s the case, then interest rate cuts by the Federal Reserve are unlikely to provide much of a boost, especially if consumers are spooked. Economists believe spending habits will change quickly from buying things to paying off debts.

Once the purses snap shut, the Fed will have to do more than cut rates by a half percentage point to convince consumers to open them again.

Keith Girard is the editor of InvestmentNews.

Related Topics: Just Thinking