Debt and "The" Consumer

By Murray, Alan P. | Business Economics, April 1997 | Go to article overview

Debt and "The" Consumer


Murray, Alan P., Business Economics


The often-repeated statement that the U.S. consumer is overburdened with debt conveys the notion that the average household's financial condition differs only in degree from that of those well-publicized few who are unable to meet their debt service obligations. We contend that such a generalization is unwarranted and leads to the erroneous conclusion that rising ratios of consumer debt to income provide a leading indicator of weakness in consumer spending.

WHEN DOES DEBT BECOME AN OVERBURDEN?

It is useful at the outset to define an overburden of debt. Because the concept is frequently associated with pessimistic forecasts of consumer spending, we view it as a level of debt that imposes obligations for the payment of interest and principal that force a household to trim its spending below what its members had been accustomed to spend and/or had expected to spend. The clearest examples are households in bankruptcy or delinquent on debt service obligations because of insufficient financial resources. But the concept extends to those who meet their debt service obligations only by cutting back significantly on accustomed outlays.

There is no question from data on bankruptcies and delinquencies that some consumers have become overburdened with debt and that their numbers rose as a proportion of all consumers in 1996. The one million plus personal bankruptcies estimated for 1996 will set a record. This is a fivefold increase over the average level of the 1970s and a 20 percent increase over the number in 1995.(1)

Bank credit-card accounts upon which a payment was thirty days or more overdue were 3.5 percent of all such accounts with outstanding balances at the end of the third quarter of 1996. While this was a somewhat lower percentage than the 3.7 percent at the end of second quarter, it was historically a high percentage and a percentage point above the 1994 rate.(2) Residential mortgage loans upon which payments were thirty days or more overdue were 4.2 percent of all such loans in the third quarter of 1996.3

The levels of and trends in personal bankruptcies and loan delinquencies are disturbing, and they may have adverse implications for consumer lenders and for investors in some asset-backed securities. But that is not the issue addressed here. Rather we ask if the problems encountered by these borrowers signal that the average or typical household is overburdened with debt. We argue that the bankruptcy and delinquency numbers do not in and of themselves demonstrate this because they represent too small a minority of all households.

The record-setting number of personal bankruptcies in 1996 will account for about 1 percent of all U.S. households.(4) The 1995 Survey of Consumer Finances reports that 6.9 percent of families with debts reported that at least one payment in the prior year was sixty days or more past due? Families with debts in turn accounted for 74 percent of all families. Thus those reporting delinquencies accounted for about 5 percent of all families. To say that the typical or representative consumer is overburdened with debt is to argue that the plight of this 5 percent provides insights into the situation faced by a majority of consumers.

DEBT TO INCOME: APPLES AND ORANGES

The ratio of consumer installment credit to disposable personal income is the statistic most often provided as the needed additional evidence that the typical consuming household is overburdened with debt. In contrast to bankruptcy and delinquency data, the income and debt totals that underlie this familiar ratio are drawn from the universe of households. Over at least the past three decades the ratio has moved in a cyclical fashion around an upward trend line.

In 1996, the ratio climbed to a new high as a percentage of after-tax income [ILLUSTRATION FOR FIGURE 1 OMITTED], higher than previous peaks associated with downturns in the economy. Before we can conclude that consumer spending is about to be drowned by a towering wave of debt, however, we need to consider that the ratio has analytical limitations. …

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