It's become a mantra: American consumers have been living beyond their means, using their homes as piggy banks, borrowing promiscuously, and now the bill is coming due. Having nearly drowned in a sea of debt, U.S. consumers must now repair their personal finances, spend more prudently and recognize the wisdom of past generations: spend only what you earn and what you have.
But while endlessly repeated by financial gurus, politicians and the proverbial man on the street, the belief that American consumers as a whole have been living beyond their means is a myth. Wall Street was massively overextended, but on average, consumers are not.
As we now know, Wall Street financial institutions, investors and some hedge funds were able to borrow in excess of 30 times their capital, which meant that for every dollar they had, they could borrow 30. That level of debt and risk far exceeded anything an individual consumer or family could do, even with the lax lending standards for home mortgages. While someone with an income of $25,000 a year might have qualified for a $300,000 mortgage during the worst excesses of the mid-2000s, it's not as if he could take that $300,000 and use it to buy a flat-screen television and stocks. But that is precisely what hedge funds and Wall Street traders did with their 30-1 leverage—buy more junk than they could afford.
It's true that certain groups of individuals were allowed to take on unreasonable levels of debt—mainly speculators and lower-income people. But taken as a whole, when compared with Wall Street, individual American consumers are the soul of prudence.
Consider the hard data. At the end of 2007, consumer debt stood at $2.6 trillion, which translates to $8,500 per person. That number includes car loans, student loans and credit cards, but not mortgages. In 2003, the figure was $2 trillion, so it is certainly true that the total amount of debt went up during the height of the housing bubble. Mortgage debt, meanwhile, more than doubled, from just under $5 trillion in 2000 to more than $10 trillion in 2008. But during this time, rates were also stable and low, much lower than the double-digit rates of the 1970s or 1980s, for instance. So while the absolute dollar figures of debt increased, the percentage of income that households spent to service their debts—including mortgage payments—nudged up only a small amount, from 13 percent in 2000 to 14.3 percent in early 2008.
Think about it. Wall Street was leveraged 30-1. In the middle of 2008, household net worth was $59 trillion, including homes, pensions, stocks and cash. Total debt was about $13 trillion, and even though that household net-worth figure has been sharply reduced in recent months, the debt-to-worth ratio was never even 1-1. That's how stark the contrast is between consumers and Wall Street.
OK, but what about those tens of millions of people falling behind on their credit-card payments or mortgages, people we read about daily? There again, the numbers reveal a more-nuanced story. What they show is that people on the lower end of the income spectrum tend to rent their homes (about half of them rent, as opposed to less than a fifth of those in upper-income brackets) and have higher "financial obligations" than those who own. In essence, if you are lower-income and rent, you have to spend a higher percentage of your income on shelter, which makes the national average look worse.
That belies that popular perception that a broad swath of the population was buying homes with too easy credit and too little income. The problem is that a few million were, just as millions did spend way beyond their means and have defaulted on their loans, whether because of health issues or sudden unemployment or bad decisions. The vast middle, the 90-plus percent who are current on their mortgages, for instance, are not the ones skewing the overall statistics or creating the general impression of overextension.
The squeaky-wheel principle applies: it is the horror stories that garner the attention, not the mundane. The tragic cases of hardworking people brought to the brink by difficult times or the morality tales of foolish spending are the stuff of financial columns and political jeremiads. And there are tens of millions of those stories in a country of 300 million people. Add a potent dollop of a longstanding cultural distrust of debt—Ben Franklin, writing as Poor Richard, called it the world's worst vice—and you get a mantra that few challenge.
Going forward, the picture for Main Street is not as grim as it is for Wall Street, even with rising unemployment. More sour mortgages threaten to plunge banks into insolvency, but hundreds of millions of consumers have already been paring back their spending, paying off debt and boosting their savings at rates not seen in the history of record keeping. Once they regain some financial stability, they will undoubtedly begin consuming again, pushing the economy forward, with less giddiness, but with the prudence that most have had all along.