Rate Cut No Balm for Debt-Laden Consumers
Wednesday November 6, 2:55 pm ET
By Dena Aubin
NEW YORK (Reuters) - For all too many Americans struggling to dig out from debt, Wednesday's surprisingly big cut in interest rates by the Federal Reserve may help very little, experts say.
Personal bankruptcy rates are rising, job growth has stalled and consumer debt is at an all-time high. So it's unclear -- even after the Fed cut rates by an aggressive one-half percentage point -- whether the tapped-out consumers can do much more to keep the economy humming.
"More and more Americans are living life styles they can't afford using borrowed money," said Steve Rhode, president of Myvesta, a financial crisis center in Rockville, Maryland. "It's not just credit cards -- it's homes too big for them to afford, cars too big for them to afford."
Said G. Ray Warner, resident scholar at the American Bankruptcy Institute, "We may actually be hitting the point where the average American consumer doesn't want to acquire more credit regardless of rates."
Consumers have powered two-thirds of U.S. economic growth in recent quarters, and much of that spending has relied on borrowed money. Eleven interest rate cuts by the Fed last year kept consumer spending robust, but that came at a troubling cost.
Credit quality has slumped, for one thing, so rates on credit cards and other loans may remain high, despite the Fed's decision to cut short-term rates to 1.25 percent from four-decade lows of 1.75 percent.
U.S. consumers were on the hook for $1.73 trillion in credit card bills, auto loans and other loans excluding mortgages through the end of August, according to the Federal Reserve, up from $1.67 trillion at the end of last year and $1.56 trillion at the end of 2000.
A critical factor ahead is how many people lose their jobs as the U.S. economy recovers slowly and sluggishly. The Fed's action reflected clear concern that the recovery is losing steam. Take a job away from the thousands of over-extended consumers and you have a recipe for rising credit defaults and personal bankruptcies.
"A rise by unemployment above the most recent peak of 6 percent in April 2002 to 6.5 percent would be a warning sign," said John Lonski, chief economist for rating agency Moody's Investors Service.
CREDIT HOUSE OF CARDS
Debt loads, as a percentage of disposable income, hit 14.39 percent at the end of last year, at least a two-decade high, the Federal Reserve reported. Personal bankruptcies rose by 8.6 percent to a record 1.47 million for the 12-month period ending June 30, according to the Administrative Office of the U.S. Courts.
Slumping credit quality has not yet sparked a broad consumer credit crunch or exerted a significant drag on growth, economists say. Yet some worry that if layoffs increase, more consumers will run into trouble paying bills, and a deeper cutback in spending will result.
The latest dive in consumer sentiment, which in October plunged to its lowest reading since 1993, suggests that debt repayment has become more burdensome, some economists believe.
A cut in interest rates could give a lift to consumer sentiment, and it will trim some borrowing costs, consumer experts say. About one-half of credit card loans are tied to variable rates, and those will fall slightly, according to the Consumer Federation of America.
"But credit card companies can turn around and increase the formula they use to calculate that rate," said Stephen Brobeck, the Consumer Federation's executive director.
HIGH-RISK DEBT SWELLS
Despite a 4.75 percent reduction in short-term rates by the Fed last year, rates on bank credit cards fell by just 1.35 percent on average, according the Consumer Federation.
According to Sara Johnson, managing director for economic forecasting firm Global Insight: "The problem is accumulated past debt, much of which is at rates that will not respond to the cut."
Another problem is growing risk on outstanding debt.
"One of the big determining factors for the rates you're charged is the risk pool you're in," said Myvesta's Rhode. "If the credit card company has labeled you as less than a prime, prime credit risk, then interest rates are probably not going to go down much at all."
Many credit card contracts also have floors on interest rates, and those were hit some time ago, said Warner of the American Bankruptcy Institute.
During the boom years of the late 1990s, companies showered consumers with easy credit, and many lent money to riskier customers, said Johnson of Global Insight.
"There was tremendous growth in lending to high-risk households," she said. "Now that we've come through a period of recession, we're seeing more defaults and delinquencies as a result of job losses."
Yet there are signs that consumers are ready to break their debt habit as they face a sluggish recovery and stagnant job market. In a recent survey by the Cambridge Consumer Credit Index, about 85 percent of consumers said they expected to trim debt over the next month, while only 15 percent said they expected to add.
A rate cut may not change that cautious view.
"It's doubtful that a rate cut will significantly diminish uncertainties regarding the outlook for consumer spending," said Lonski, the Moody's chief economist. "It by no means will assure a significantly stronger holiday shopping season." |
