Saturday, July 17, 2004

Our Murky Economic Undertow Plagued by Lurking Financial Sharks

Indebted U.S. Ponders Maggots, Robbery
Sat Jul 17, 7:28 AM ET
By Alister Bull
WASHINGTON (Reuters) - A mouthful of maggots could not deter Michele Goncalo from vying for a $50,000 prize in a television game show because, like millions of other Americans, she wants to clear her credit-card debts.

Besides tasting insect larvae on "Fear Factor," she crawled out of a helicopter as it hovered over a chilly lake.

But luck was not with her. Goncalo was eliminated from the show, and a few weeks later the Federal Reserve (news - web sites) raised interest rates for the first time since 2000.

U.S. consumers are laboring under more than $2 trillion in debt after years of easy credit. And with that era drawing to a close, the plight of those who borrowed too much has fallen under a harsh spotlight.

Goncalo declined to be interviewed, but she said on "Fear Factor" that if she won the prize, she would use it to wipe her slate clear of debt.

Others whose obligations have gotten out of hand say constant demands for payment can quickly create a sense of desperation.

Ric Wade, who had $16,000 in debts after renovating a house he couldn't sell, said he was getting six calls a day from credit-card companies.

"I told them I just don't have the money," the South Miami resident said. "I can go and rob a bank?"


Americans possess more than 600 million credit cards, or 4.8 for every holder in the country, and have loaded that plastic up with some $700 billion.

Wade turned to a nonprofit credit counseling organization -- a growth industry in the United States -- and got his monthly bills cut to $450 from $1,400 under a four-year repayment plan he hopes to complete ahead of schedule.

"We're a consumer nation, and advertising works," he said. "They create demand and you feel that you've got to have it ... They don't ask 'Can you afford it?' You just look at the monthly payments, and suddenly you can afford it."

Affordability has become less certain after the Fed's June quarter-point rate hike to 1.25 percent, which economists see as the first of a number of moves to keep inflation tame.

According to the influential Blue Chip survey, top economists on average see the fed funds rate at 2 percent by year-end and 3.5 percent by December 2005.

How debtors react to the pinch from rising borrowing costs is important in an economy where consumer spending accounts for roughly two-thirds of gross domestic product.

Market interest rates, which are influenced by the fed funds rate but set independently, had climbed even before the Fed moved on June 30. Their rise was among the factors blamed for weaker household spending in the second quarter.

But Fed officials have repeatedly said they don't think consumers are at risk from tighter monetary policy even though household indebtedness stands at a record and debt service levels, a measure of monthly interest obligations as a percentage of disposable income, are also near their peak. 

One reason policy-makers remain sanguine is that many households used low interest rates to consolidate debts into single, longer-term loans.

This pushed up debt levels, but disguised an underlying improvement in the strength of household finances and their ability to absorb higher interest rates, Fed officials say.

"Although there are pockets of financial stress among households, the sector as a whole appears in good shape," Federal Reserve Board Governor Susan Schmidt Bies said on Thursday.
But those dealing daily with people drowning in debt see enormous problems.

"This will hurt the middle class, families on $30,000-$70,000 a year," said Howard Dvorkin, founder and president of Consolidated Credit Counseling Services in Fort Lauderdale, Florida.


Americans received 4.9 billion unsolicited offers for credit cards through the mail last year. While the success rate of these marketing efforts is just 0.6 percent, a lot of the wrong people have been tempted into signing up.

Dvorkin has students with no current income turning up for counseling after charging thousands of dollars to their cards. His average customer has $23,000 on plastic.
Nor is it just credit cards. Some people are also having trouble repaying bank loans, and higher interest rates would only make this more difficult.

Dvorkin calculated that a 2 percentage-point increase on a typical 20-year, variable rate home equity line of $50,000 would raise the final interest bill by $60 a month, or $14,000 for the life of the loan.

"These families are doing what they have to do (to get by)," he said, "but a 2 or 3 percentage point rise in interest rates will hit them pretty bad."

Would this make a difference to spending? Definitely, say people at the receiving end.
"If rates go up, it makes everything more of a struggle," said Ted Long, now within a couple of months of completing a debt workout thrashed out in counseling. "It would have had a severely negative impact on our financial decisions if we still had the credit card debt we had back then."
Long and his wife ran up $11,000 on cards and were paying $650 a month -- more than the rent on their Hollywood, Florida, home -- before going to the counselors.

"I didn't wake up one morning and decide 'I'll want $11,000 credit,' but it just builds up little by little," Long said. "People think credit cards are like money or a paycheck, and that is so wrong."

How can the United States continue to sustain a thriving middle class consumer base when their careers are being threatened and at the same time having their financial stability eroded by daily compounded interest?
I believe that Critical Mass has been achieved in this area. Would you choose to remove it from our economy as you would a wart?


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