We’ve Still Got Room to Spend

It's become a mantra: American consumers have been living beyond their means, borrowing promiscuously, and now the bill is coming due. Having nearly drowned in a sea of debt, U.S. consumers must now repair their finances, spend more prudently and recognize the wisdom of past generations: spend only what you earn. But while endlessly repeated by financial gurus, politicians and the media, 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 were able to borrow in excess of 30 times their capital, which meant that for every dollar they had, they could borrow more than 30. That level of debt far exceeded anything an individual consumer could take on. 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 the total amount of debt did go 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, 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. So while Wall Street was leveraged 30-1, in the middle of 2008, household net worth was $59 trillion (including homes, pensions, stocks and cash), while total debt was about $13 trillion. 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 lower-income people tend to rent their homes and have higher "financial obligations" than those who own. They spend a higher percentage of their income on shelter, which makes the national average look worse.

That belies the 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. But the vast middle, the 90-plus percent who are current on their mortgages, 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—and there are tens of millions of horror stories in a country of 300 million people. But thanks to the fiscally fit majority, 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.

Karabell is president of New York–based River Twice Research.

© 2009