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Interest Rates, Bankruptcy and the American Dream With some Wall Street and other economic indicators suggesting the existence of a healthy economy, Alan Greenspan's Federal Reserve is expected to raise interest rates next week. What does it mean for the role the economy plays in the Presidential election? Harvard Law professor Elizabeth Warren, author of THE TWO-INCOME TRAP: WHY MIDDLE CLASS MOTHERS AND FATHERS ARE GOING BROKE, says, "The American family is about to get hit with a tidal wave from the debt they've taken on. And that tidal wave is going to drown millions of families."
This sentiment was echoed by the THE ECONOMIST. It's "Buttonwood" column said bluntly that the low interest rates have been bad for Americans:
Unfortunately, keeping them so low for so long has made a bad problem worse, because it has caused a stampede into assets—houses—that are now horridly expensive by any reasonable measure; and because a big chunk of those assets is now financed with floating-rate rather than fixed-rate mortgages.
In fact, American borrowing is at record levels. In 1994 when interest rates went from three percent to six percent, the average household's debt load amounted to about 9 percent of disposable income. Today, the figure is nearer 18 percent, and in part because of lower rates, consumers keep adding debt.
Especially worrying to some experts is the upsurge in Adjustable Rate Mortgages (ARMs) being signed up for by home-seekers. As opposed to fixed-rate mortgages, which can be exchanged with no penalty when rates fall, the ARM's rate may change, usually in response to changes in the Treasury Bill rate or the prime rate. ARMs are tied to short-term interest rates, much lower than long-term rates, making them more attractive due to the long period of low short-term rates, but also making them more risky for borrowers.
According to industry statistics, in the past most Americans (four-fifths) decided on fixed-rate mortgages, but this quarter the number opting for ARMs has reached a ten-year high — with half of the borrowers taking adjustable rates. Some economy watchers are also worried about the rise in home-equity credit; Americans have borrowed against their homes to the tune of $250 billion. These loans are also usually variable in rate. According to THE ECONOMIST's own tracking of the American housing market, property prices have risen by over 50 percent since 1997, but wages have not kept up — the ratio between them is also at record highs.
And then there's the general rise in all forms of debt. A recent study by Benjamin Tal and Avery Shenfeld, economists at CIBC World Markets, speculates that almost a quarter of all household debt would immediately be affected by higher rates. That's 70% higher than in 1994.
Consumer Bankruptcy Filings and
Debt Payments as % of Disposable Personal Income |
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1980: Total consumer bankruptcy filings:
Debt Payments as % of Disposable Personal Income: |
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300,000
12.9% |
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1985: Total consumer bankruptcy filings:
Debt Payments as % of Disposable Personal Income: |
|
290,000
13.6% |
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1990: Total consumer bankruptcy filings:
Debt Payments as % of Disposable Personal Income: |
|
700,000
13.4% |
|
1995: Total consumer bankruptcy filings:
Debt Payments as % of Disposable Personal Income: |
|
850,000
12.6% |
|
2000: Total consumer bankruptcy filings:
Debt Payments as % of Disposable Personal Income: |
|
1,200,000
13.7% |
|
2003: Total consumer bankruptcy filings:
Debt Payments as % of Disposable Personal Income: |
|
1,600,000
16% |
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