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Is the era of easy credit over for the long haul?
2008-10-12
An inflatable gorilla beckoned from the roof of Don Brown Chevrolet in St. Louis, servers doled out free bowls of pasta and a salesman urged potential customers to "come on up under the canopy and put your hands on" a new set of wheels. Muzi.com News 10081065-1 (muzi.com)But sitting across from a salesman in a quiet back room, Adrian Clark could see it would not be nearly that easy. This was the ninth or tenth dealership for Clark, a steamfitter looking for a car to commute to a new job. Every one offered a variation on the discouragement he was getting here: Without $1,000 for a downpayment, no loan. Muzi.com News 10081065-2 (muzi.com) "It's just rough times right now," Clark said. "Rough times." Muzi.com News 10081065-3 (muzi.com) For Clark, and for a nation of consumers heavily dependent on credit, there are growing signs that those rough times could prove to be more than just a temporary problem, that they could be the beginning of a stark, new reality. Muzi.com News 10081065-4 (muzi.com) Is America's long era of easy credit over? Muzi.com News 10081065-5 (muzi.com) Experts say that even when the current credit crunch eases, the nation may finally have maxed out its reliance on borrowed cash. Today's crisis is a warning sign, they say, that consumers could be facing long-term adjustments in the way they finance their everyday lives. Muzi.com News 10081065-6 (muzi.com) "I think we're undergoing a fundamental shift from living on borrowed money to one where living within your means, saving and investing for the future, comes back into vogue," said Greg McBride, senior analyst at Bankrate.com. "This entire credit crunch is a wakeup call to anybody who was attempting to borrow their way to prosperity." Muzi.com News 10081065-7 (muzi.com) A prolonged period of tighter credit is ahead, experts say. Muzi.com News 10081065-8 (muzi.com) U.S. consumers will find it much harder to get a credit card, and to carry large balances. Late fees will rise and lines of credit will be reined in. After years of buying homes with interest-only loans, or loans that allowed people to borrow more than the value of the home, substantial payments and downpayments will be required. Interest rates are also likely to rise. Muzi.com News 10081065-9 (muzi.com) Lenders, far more wary of risk, have tightened the standards they use to judge potential borrowers. Regulators will be looking over their shoulders. Muzi.com News 10081065-10 (muzi.com) The changes cap three decades in which U.S. consumers -- along with businesses and government -- have run up ever-increasing debt. Americans became accustomed to financing purchases large and small with plentiful credit cards, easily approved loans for cars and the latest conveniences, and by siphoning the equity in their homes. Lenders did far more than just make credit plentiful. They aggressively marketed it as a necessity, a way for the smart consumer to leverage themselves into a better lifestyle. Muzi.com News 10081065-11 (muzi.com) The financial meltdown has made clear the role an increasingly global economy played in facilitating U.S. consumers' borrowing, with banks packaging and selling debt to investors, providing cash to people who once would have been considered too risky to get a loan. Muzi.com News 10081065-12 (muzi.com) The expansion of credit has, in many ways, been a good thing. It has allowed many more people to buy homes. At a time when household incomes have stagnated, borrowing has made it possible for many people to afford purchases and cover short-term expenses they might otherwise have had to delay or abandon. Muzi.com News 10081065-13 (muzi.com) But all that borrowing came at a heavy cost. Muzi.com News 10081065-14 (muzi.com) • Americans are more reliant on debt then ever before. Muzi.com News 10081065-15 (muzi.com) The portion of disposable income that U.S. families devote to debt hit an all-time high in the second half of last year, topping 14 percent, figures from the Federal Reserve show. When other fixed obligations -- like car lease payments and homeowner's insurance -- are added in, about one of every five household dollars is now claimed by bills. Muzi.com News 10081065-16 (muzi.com) The credit card industry lobbied heavily in 2005 to tighten bankruptcy laws to make it more difficult for consumers to seek court protection and shed responsibility for paying off debt. But in a sign of just how much households have become dependent on borrowing, the average amount of credit card debt discharged in Chapter 7 bankruptcy filings has tripled -- to $61,000 per person -- from what it was before the law was passed. Muzi.com News 10081065-17 (muzi.com) "We are going to have to cut back," said Dean Baker of the Center for Economic and Policy Research, a Washington, D.C. thinktank. "We've really been living beyond our means." Muzi.com News 10081065-18 (muzi.com) • Americans, borrowing to cover ordinary living expenses, have all but abandoned saving. Muzi.com News 10081065-19 (muzi.com) The U.S. personal saving rate dropped to well below 1 percent in late 2007 and early this year, according to figures from the federal Bureau of Economic Analysis. The figure has edged up in the last few months, but the actual savings rate may still be near zero, given that many people are covering living costs by using credit cards or money saved earlier, according to the BEA. The lack of savings is a sharp contrast with the decades after World War II. Americans routinely saved more than 10 percent of their income in the early 1970s. Muzi.com News 10081065-20 (muzi.com) Now, many families spend virtually all of their incomes covering living expenses, and even that is not enough. Muzi.com News 10081065-21 (muzi.com) "In the credit era, which is like living on steroids, you're not saving money, you're not breaking even. You're actually borrowing 20 to 30 percent," said Robert Manning, author of "Credit Card Nation: The Consequences of America's Addiction to Credit." Muzi.com News 10081065-22 (muzi.com) The new era of tighter credit will largely be a mandate, as consumers are forced to adjust to tougher rules and tighter limits. But consumers have also begun showing signs of a change in mind-set, putting off purchases, buying less expensive substitutes, going out to eat less, and rethinking their propensity to do so on credit. Muzi.com News 10081065-23 (muzi.com) Consumer borrowing fell for the first time in more than a decade in August, the Federal Reserve reported this week. The decline, at annual rate of 3.7 percent, reflected a sharp drop in the category of borrowing including auto loans and a smaller decline in the category including credit cards. Muzi.com News 10081065-24 (muzi.com) The tightening of credit will force American families to cut their spending, mindful of their current paychecks instead of borrowing against future ones, said Frank Badillo, senior economist with TNS Retail Forward, a consulting and market research firm in Columbus, Ohio. Muzi.com News 10081065-25 (muzi.com) "We're going to see some fundamental changes in consumer behavior," he said. Muzi.com News 10081065-26 (muzi.com) Badillo and others compare the psychology to the way people reacted after gasoline reached $4 a gallon last summer. Prices have eased considerably since then, but consumers seem to have decided that the good old days of very cheap gasoline are over. In response, people have moved to buying smaller, more efficient cars, and trying to reduce the miles they drive. Demand for homes in outlying suburbs has declined. Muzi.com News 10081065-27 (muzi.com) Like gasoline prices, the availability of credit should improve once the current crisis eases. But consumers are confronting what some see as a long-term change. Muzi.com News 10081065-28 (muzi.com) After years of living off one income and drawing on credit to fill the gap, Portland, Ore., legal assistant Susie Shepherd and her partner, Kaite Chase, are rethinking their finances. In the past few years, they regularly ran up debt to pay Chase's tuition and repeatedly refinanced their home, pulling out equity to pay bills and drawing on lines of credit to cover expenses. Muzi.com News 10081065-29 (muzi.com) But Shepherd was caught short this fall when her brother asked for help in paying moving expenses. She tried to draw on a credit card, but found her line of credit had been cut in half. The only way to help, the couple decided, was to sell some household items. Muzi.com News 10081065-30 (muzi.com) "We'd been living on credit for so many years," Shepherd said. Muzi.com News 10081065-31 (muzi.com) Borrowing against the future has always been part of the American story. Muzi.com News 10081065-32 (muzi.com) "How did those religious English people get to this country on the Mayflower? They came on what we would call the installment plan," said Lendol Calder, author of "Financing the American Dream: A Cultural History of Consumer Credit." Muzi.com News 10081065-33 (muzi.com) But the Great Depression chastened consumers. After World War II, and the explosive growth of the suburbs, consumption rose sharply. But the modern era of easy credit really began with the deregulation of the late 1970s. Muzi.com News 10081065-34 (muzi.com) In a 1978 Supreme Court decision, banks won the right to charge whatever interest rate their home state allowed and to do so across state lines. States repealed usury laws capping interest rates. Banks began pursuing consumers in ways they hadn't before. Muzi.com News 10081065-35 (muzi.com) When inflation soared in the early '80s, banks aggressively marketed credit cards to struggling consumers as a good deal. The interest rates were high, but not as high as inflation. In the recession of 1990-91, banks who saw their profits tightening seized on the margins available by lending more to consumers. When Congress eliminated income tax deductions for interest on credit cards, banks pushed home equity loans, encouraging people to take money out of their homes to pay off the credit cards. Muzi.com News 10081065-36 (muzi.com) As families took on debt, they were encouraged to follow a rule of thumb: It's OK as long as you don't devote more than 25 percent of income to borrowing costs. Muzi.com News 10081065-37 (muzi.com) Lenders, though, found a way around that. The 20-year home loan was repackaged as a 30-year loan and lenders stretched three-year car payment schedules to seven, masking the extent of the debt load. Muzi.com News 10081065-38 (muzi.com) Consumers "think they're doing fine by their parents' standards," Manning said. "But boy, have they fallen far behind." Muzi.com News 10081065-39 (muzi.com)
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