Another Financial Crisis Looming?

Could anything be worse than the foreclosure crisis? People who purchased more expensive homes than they could afford or used risky mortgages to obtain them are losing their homes in record numbers. Banks who aggressively pushed loans on poorly qualified borrowers are suffering the consequences. The economy has been dragged down by the crisis. Will this be the last financial crisis? Unfortunately, no.

While mortgage debt in this country is somewhere in excess of $10 trillion, it is secured by the underlying real estate. While lenders suffer losses in the foreclosure process, they do generally recover something. The looming problem is with consumer debt, both secured and unsecured. Secured debt would be auto loans and other obligations backed by an asset. Like home mortgages, the assets could be repossessed if the buyer defaults and the lender stands to make at least a partial recovery.

It is the unsecured debt, mainly credit card, that is looming as a huge problem. According to the Federal Reserve, consumer debt was more than $2.55 trillion as of December 2008. Almost $1 trillion of that was revolving (credit card/line) debt. It is the unsecured debt that is the riskiest form for the lender. It can be wiped out through bankruptcy or otherwise be difficult to collect when a borrower defaults.

Unprecedented Growth

In 1999 consumer debt was approximately $1.5 trillion, ten years later it is 70% higher. Household income has been fairly stagnant during this same period of time. What does this mean? It means that people have been using credit to fund a lifestyle that is higher than their income would justify. Big surprise.

Just as they did with mortgages, banks have aggressively marketed credit cards, often to people who shouldn’t have them. Their insatiable thirst for bottom line profits have left them with another time bomb of “toxic” assets. As the recession deepens more and more of these borrowers will default. People are using credit cards to hang on to a standard of living that no longer exists. What will they do when there is no credit left on those cards?

Foreclosures are a much more visible consequence. Vacant houses with for sale signs with a banner reading “bank owned” illustrates the situation clearly. Credit card defaults aren’t so easy to spot but the consequences are just as ugly. Many banks will have their ability to lend impaired or fail altogether because of this. Just another turn in the downward spiral we are in.

The Cash Standard

The country as a whole needs to return to a time when we saved to buy what we wanted instead of expecting instant gratification. Credit should be used for emergencies, and a 50% off sale at Macys is not an emergency. The paradox is that for the economy to recover consumers need to spend money. The Government understands this and indicated as much with the tax cuts in the recent stimulus package. Rather than sending people checks as they did in 2008, the cuts will show up in weekly paychecks. It is such a small amount that, in theory, people will just spend it and it will stimulate the economy. We’ll see how it works out this time.

In his book, The Total Money Makeover, financial guru Dave Ramsey advocates using cash instead of credit or debit cards. Studies have shown that people will spend significantly less when paying with cash as opposed to plastic. He is also a proponent of living a debt-free lifestyle and advises people to eliminate their debt as quickly as possible.

Try this challenge: for the next week leave the credit and debit cards at home. See if you spend less by using cash. More importantly, see how much more attention you pay to your purchases.

Debt, n. An ingenious substitute for the chain and whip of the slavedriver.
– Ambrose Bierce

Article Author: Richard Warren

Richard has written 109 articles for us.
Visit Richard's Website: http://www.rehabberseye.com

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Tagged as: credit card defaults, credit crisis, dave ramsey, recession