Can You Live Without Debt? - Analyst Blog

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Remember the fictional immigrant Balki from the TV show "Perfect Strangers"? He seemed to speak a universal truth when he said, " Am I in debt? I'm a true American. "

Well, not anymore. After being battered by the latest recession, Americans are gradually learning to live without debt, priming protection over growth.

According to a report released by the New York Federal Reserve, U.S. consumers continued to free themselves of debt in the third quarter, showing a 0.6% sequential decline. The decline was primarily led by reduced mortgage balances.

Consumer debt increased substantially during 2002-2008. In 2007, consumer debt had swollen to about 135% of disposable income. Since then, the level has been seeing a steady decline.

It is a common perception that living without debt is just impossible, as our society has structured certain high-value consumptions like higher education, cars and homes that translate to our future financial growth. And these consumptions need big dollars, for which you often need a loan.

So, before looking at the detailed consumer debt data for the reported quarter, let's take a look at the feasibility and boon/bane of a debt-free situation.

Discard Debt Mania

There could be a better way to keep ones life cycle intact even without the regular credit. The demerits of a debt burden are not unknown to any of us. Naturally, nobody wants to get involved in one.

But our society and lifestyle force us to think mechanically. Have you ever taken a loan with the intention of fueling economic growth? Of course not. We indulge in loans to make ourselves wealthy, forgetting the wonders that savings and wiser spending can do. Perhaps tighter purse strings and a saving habit are all we need to better serve ourselves our own needs and those of our economy.

Though moving toward a debt-free economy will make it difficult for policymakers to frame growth models in the near term, this could be a positive for the long-term health of the economy, making lives easier for generations to come.

What is Consumer Debt?

In economics, consumer debt implies a fund for individual consumption and not investment. Theoretically, this fund should be used for the purchase of consumable goods that do not appreciate in value directly or indirectly.

However, in reality, consumer indebtedness for anything -- from consumption to investment -- is counted as consumer debt.

Any Good for Economy?

In post-Keynesian economics, consumer debt is viewed as an instrument to increase domestic production. If consumers get easy credit to step beyond their real purchasing power for valuable consumption, consumer goods will be in hot demand. Consequently, the demand surge should translate into higher overall domestic production.

According to economist Milton Friedman's permanent income hypothesis, consumers take major loans to finance their big expenditures like housing and schooling earlier in their careers to make life circles smooth and constructive. These expenditures help motivate them to earn more and repay debts. So, a complete consumer debt cycle helps the economy move forward with higher domestic production.

The permanent income hypothesis has proven its worth in South Korea. The increase in South Korean consumer debt has significantly fueled its economic growth.

But the consumer debt model is neither the mandate, nor the mantra for GDP improvement in every country. Credit card debt is almost unfamiliar in Japan and China. But these countries are progressing well, with China being an undisputed economic forerunner. These two countries made this possible with their long-standing social mindset against consumer debt. So why can't America?

Are Americans Attempting?

According to the report issued by the New York Federal Reserve, total consumer indebtedness stood at $11.66 trillion at the end of the third quarter, down approximately $60 billion or 0.6% from the revised second quarter total of $11.72 trillion.

A major debt reduction was witnessed in real estate during the quarter. Mortgage indebtedness fell 9.6 % from its peak. Also, the number of people applying for new mortgage loans decreased 17%. This reflects that Americans no longer prefer to buy a home with a huge loan as the value appreciation of landed property is uncertain.

Credit card debt fell marginally to $693 billion. Also, the number of open credit accounts declined 23% from its peak in 2008. Aggregate credit card limits were down.

Though student loans increased marginally to $865 billion from $845 billion in the prior quarter, this was below market expectations. According to Lauren Asher, president of the Institute for College Access and Success, student loans typically increase during recessions, particularly for higher education, as people tend to seek more education with the expectation of a better job and better pay.

On the flip side, the number of people defaulted on their payments increased during the quarter. At the end of September, the delinquency rate increased to 10% from 9.8% at the end of June. Also, the number of credit inquiries increased during the quarter.

However, in October, credit card companies reported mixed results, with Bank of America Corporation ( BAC ), Citigroup Inc. ( C ), American Express Company ( AXP ) and Discover Financial Services ( DFS ) witnessing lower delinquency rates, and JPMorgan Chase & Co. ( JPM ) and Capital One Financial Corp. ( COF ) experiencing the opposite.

We think the overall declining trend of consumer debt reflects the willingness of Americans to offload their debt burden. We are also appreciative of the recent government regulations that have gone a long way to change customer habits to a great extent. In this context, the Dodd-Frank Wall Street Reform Act is worthy of mention. It has forced credit card issuers to tighten credit standards, making credit card debt less accessible to consumers.

Languishing Consumer Confidence?

One school of thought argues that the decline in consumer debt is just a reflection of lower consumer confidence. With shoppers seeing fewer promises from the economy as it continues to lack luster, they are changing their buying habits and cutting down their consumption borrowings.

However, the data released by the Conference Board on Tuesday reveals that the Consumer Confidence Index increased to 56.0 in November from 40.9 in October. This is the highest since July, when the index hit 59.2.

Also, according to the data from the Commerce Department last week, consumer spending, which accounts for two-thirds of the economy, grew the fastest in third quarter so far this year. In fact, the quarter saw an annualized growth rate of 2.3% for consumer spending.

In fact, earlier this week, the National Retail Federation said that retail sales during the Thanksgiving weekend climbed 16.4%. On average, consumer spent $398.62, up 9.1% year over year. Cash counters kept ringing and retailers including Best Buy Co. Inc. ( BBY ), Macy's Inc. ( M ) and Wal-Mart Stores Inc. ( WMT ) enjoyed a weekend of significant gains.

So, it's obvious that the consumer sentiment for buying consumables is still strong. The only difference is that they are actually reducing their borrowings for consumption.

No Pain, No Gain!

You don't have to worry about getting consumer spending back on track. The policymakers will do that for you. There's a far simpler job for you - just cut your coat according to your cloth!

Obviously, no one wants you to change your lifestyle overnight. That's impractical. But the effort to live a debt-free life should continue. Each small step taken could be a giant leap for the economy.

Most importantly, we need to focus more on savings, so that gradually we can finance our own mega-spending for home, education or a car.

Debt avoidance will call for sacrifices initially. But if you can make yourself debt-free, you are an assured winner of life-long financial security and peace of mind.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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