Commentary: The death of the consumer is greatly
exaggerated
By
Doug Duncan • Special to Bankrate.com
 Doug
Duncan, senior staff vice president/chief economist at the Mortgage
Bankers Association of America, wrote this commentary for Bankrate.com.
Consumer debt warnings are up everywhere. Bankruptcy
is running at record levels. The subprime lending market is thriving.
People are refinancing their credit card debt into their homes.
How can the economy survive this latest crisis?
The economy will survive just fine.
We can't find any evidence that there was ever a recession
caused by an excess of consumer debt. It does seem that consumer
debt loads may have accentuated the depth of a few recessions, but
the recessions started from other causes.
We don't expect the current level of consumer debt
to cause a recession nor to slow the recovery. In fact, consumers
seem quite healthy from a financial perspective to us, having just
restructured their balance sheets through a massive volume of mortgage
refinance activity.
Why is consumer debt so
high?
Let's explore the mortgage aspect of consumer debt first. Indeed,
some folks did refinance their first mortgage, take out some cash,
pay off their credit cards and subsequently run up their credit
cards again. However, that is the exception rather than the rule.
The single biggest use of the cash taken out was for home improvement,
which means the borrower was making improvements to the asset being
borrowed against. Even so, this isn't the main reason mortgage debt
increased.
The most important reason for the increase in consumer
debt is that about 10 million of them bought their first home over
the last decade. The homeownership rate has risen to an all-time
record of 68.4 percent of all households as a result. In order to
purchase a home, most consumers took out a mortgage. In my last
column, I noted that for the last few years, the after-tax monthly
mortgage payment on a typical 80 percent loan to value mortgage
was actually below a typical rent as described in the Consumer Price
Index. That is why rental property vacancy rates are at an all-time
high of 9.6 percent. People bought a house rather than pay rent
and the mortgage payment was a better deal.
The balance sheets of those former renters now show
mortgage debt whereas before they showed none. By implication the
renters have an ongoing expectation of making monthly payments but
no actual debt. In fact, the renters' balance sheets show cash where
the owners' balance sheets show equity in a home in the amount of
cash used in the down payment. The renters show no asset related
to housing but the owners show the value of the house as an asset.
What does all this mean?
Consumer debt rose. The homeownership rate rose. But
the consumers bought an asset that gives them both wealth-building
capability and housing services. Are they worse off? Doubtful. Equity
in the home is the largest source of wealth for the median-income
family in the country.
Most of the households that refinanced in 2003 --
$2.5 trillion dollars of refinancing occurred including the cash-out
amount -- lowered their monthly payment. Even some of the ones that
took out cash ended up with the same size monthly payment because
interest rates were lower on the new, larger loan. Therefore, most
households will have more cash available on a monthly basis than
before. Plus, the interest anyone was paying on credit card debt
that was subsequently refinanced into the mortgage is now tax deductible
whereas before it was not. And, as households' incomes grow and
their mortgage payments don't, their disposable incomes grow.
Thrifty uses of credit
What about credit card debt? I often ask crowds to raise their hands
if they've bought groceries with a credit card. To all those who
raise their hands (the vast majority of those in the room) I say
my mother wants to talk to them. My mother would have been appalled
at the idea of using credit to buy something that is consumed immediately.
Are these people spendthrifts? No. In fact, they may
be thrifty.
With cash you get no frequent flier miles. If you
lose cash, the probability of it being returned is practically nil,
but if you lose a credit card the most you are out is $50. Credit
cards allow you to track your exact expenditures on a monthly statement
-- cash doesn't. If you make repeat trips to the ATM to withdraw
cash, you may pay fees for the privilege. But if you pay your credit
card bill in a timely manner, you get to use someone else's money
for free while your cash is earning interest in the bank. (Incidentally,
Mom still shakes her head at the groceries-on-credit concept.)
Thus, credit cards are financially efficient, if used
wisely. The level of consumer debt shows an increase in the credit
card category, but is it a problem? Some folks run up unsustainable
levels of credit card debt and get in trouble, but for the majority
it is a benefit rather than a problem.
Another factor affecting the rise of consumer debt
is the dramatic increase in auto loans. But wait: All those auto
companies were offering interest-free loans to get consumers to
take the leap. The result was consumers used someone else's money
for free. The average length of an auto loan is greater also, up
to five years in some cases, and this increases the amount of consumer
debt outstanding. Coincidentally, the life expectancy of an auto
has lengthened so consumers are matching the financing period to
the useful life.
It is certain that the dollar amount of debt on consumer
balance sheets has risen. It is doubtful whether this is a bad thing.
On balance, I think consumers are well positioned financially. They've
improved the long-term strength of their balance sheet, lowered
their debt costs and acquired assets for the future.
The consumer is not dead; long live the consumer.
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