Another Financial Crisis Looming?

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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 visa-mc-discoverproblem. 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 total-money-makeoveradvocates 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

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  1. i would recommend to the author that author to not only put the numeral amounts of the consumer debt and mortgage but also how it relates to GDP. by putting the percentage of GDP into this it provides an accurate perspective for the reader. also by putting the % of GDP it adds substance to a statistic that lacks it in your article.

  2. Some facts like consumer debt was more than $2.55 trillion as of December 2008 are astonishing! This is a better idea to build some confidence to face the current crisis of recession-to go out for some days with out credit and debit cards… Really it will work out..I tried this.

  3. This was a great article…although I do have to say that the 50% off at macys may just constitute an ’emergency’ 🙂

    kidding. I understand the point – and its true when you use cash only you really watch your funds alot more than swipping a credit card.

  4. The credit crunch is going to have a greater effect on us than we think, including those with good credit.Perhaps I should say those who use to have good credit. When the crunch is over who will be left with a good credit score? Yes we need to pay off as many debts as we can now. If you still have it cash is king.

  5. I have just come across this site and its filled with great content, interesting and informative.

    They said that it was going to start easing up, but to be honest I have not felt that, in South Africa things are really tough and we are really starting to see the worst of it now with businesses not been able to cope and keep their heads above water, food prices keep rising and people here are really buying less, lets just hope that something starts to turn around soon, but in the mean time we just have to keep pinching to hang in there.

  6. Financial growth is very essential to came out of recession and avoid the fear of double dip recession. Economy seems to be moving in positive direction now few positive changes on consumer goods data and market sentiments will become positive then after.

  7. On the one hand many people are concerned that those responsible for the financial problems are the ones being bailed out, while on the other hand, a global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. The problem could have been avoided, if ideologues supporting the current economics models weren’t so vocal, influential and inconsiderate of others’ viewpoints and concerns.

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