Academic journal article ABA Banking Journal

Another Day Older and Deeper in Debt

Academic journal article ABA Banking Journal

Another Day Older and Deeper in Debt

Article excerpt

CONSUMER SPENDING HAS been the backbone of the U.S. economy since the collapse of business investment spending triggered the 2001 recession. Although signs of a rebound in business investment have emerged, that improvement is still tentative. Meanwhile, personal consumption expenditures increased during the recession and have continued to rise despite weak labor market conditions and sluggish income growth during this "jobless" recovery.

A steady diet of debt, spiced up by historically low interest rates, has helped fuel the consumer spending marathon. From zero-interest vehicle loans to cut rate mortgages, consumers have continued to pile on debt, such that total household debt was close to 113% of disposable (i.e., after-tax) income during 2003's second quarter. It is often more critical to assess the ability of borrowers to service their debt. The debt service burden measures monthly debt service payments--interest plus principal--as a share of disposable income. Lower interest rates have held the monthly debt service burden roughly constant at around 14%, leaving it just below historical highs (see chart). Consumers have utilized low interest rates to refinance and/or consolidate their debts, thereby adding to their overall level of debt and failing to work down their monthly debt service burdens. This leaves households--and, by extension, the economy--vulnerable to rising interest rates. Since reaching its low point in mid-June, the yield on a 10-year Treasury note has climbed by more than 125 basis points to near 4.40%.

An immediate downside risk of rising interest rates is the impact on mortgage refinancing activity. …

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