Friday, January 25, 2008

Economics Even I Can Understand?

To begin with, I'm not a math person. I'm not an economist. I can't tell you about the theory of what's going on with the markets, or how tariff laws affect the price of eggs in China. But I'm seeing a lot of press out there on the recession, and it seems to have somehow taken people by surprise. I'm also seeing several articles focusing on the downturn in housing, as if it were a cause of the crisis and not simply one factor in the equation. Most recently, I'm seeing plans to throw consumers a small tax bone, apparently in the hopes they will take that right out and splurge on something nice, and that spending surge will magically jump-start our flagging economy. Apparently, the current wisdom is that Jane Consumer is to blame for the recession because for some mysterious reason, she's stopped spending so much.

In light of that, I have some humble observations to share, from the perspective of Jane Consumer as the middle-class American. Not the stereotypical irresponsible spender flinging money out the window. Not the uneducated victim of predatory financial purveyors. The normal, everyday Jane.

Earlier in the decade, the housing market was good. Interest rates on home loans were low - 2002 saw the lowest interest rates in 35 years. In fact, the market was so good homeowners were making remarkable amounts of money simply by living in their homes:Owners of median-priced homes at $269,000 in Southern California "earned" $38,977 -- or $3,248 a month -- just by holding on to their properties in 2002.

So what's a young consumer to do? Rent? Not on your life. The current wisdom was to buy, and to buy "as much house as you could afford."

So let's hypothesize a Jane Consumer and her family, with a student loan, a moderate (read: not unreasonable or dangerous) amount of credit card debt at reasonable rates between, say, nine and fourteen percent. She's also got car payments, and maybe a kid or two. Recently, she's made the decision to "invest" in a house, rather than throwing away her money paying rent.

During the shopping process, Jane Consumer does the math. How much do you have on credit cards? What are your other monthly bills? Add it all up, figure in normal spending, some splurges, and a bit for emergencies, and then invest the rest of it in a house. With careful calculations, Jane realizes that she can't afford a really nice house, but can take on a moderate home with a few fix-ups needed. Now, what kind of loan?

Well, the monthly payments on a fixed-rate mortgage are higher. And right now, just starting out, Jane's salary is on the low side. But she's got a viable career and good prospects, so the banker recommends one of the adjustable rate mortgages. By the time her payments go up, so does her salary. And you can always refinance, right?

For the purposes of this story, let's say she chooses either a 30-year fixed or a non-"predatory" ARM - something not too volitile, no poster child for the Poor, Misinformed Victim here. Just a normal mortgage that's about right for what she can afford.

So Jane moves in with her family, and while the money's a bit tight, it's workable. With credit card payments, car payments, house payments and so forth, they've got just about enough spending money. They've even managed to start saving a modest couple of hundred per month.

Fast forward a few years. In 2005, as part of the Bankruptcy Abuse Act, credit card companies' minimum payments doubled. Jane's salary has gone up, but not at that rate. It starts to become difficult to make the monthly bills. Some juggling has to be done. Nothing serious, just a bit of a hassle. And no leftovers for savings.

But over the next several years, there's more . . .

Her credit card companies look at how much total debt she's carrying, and raise her interest rates.

She gets her monthly car insurance bill, and finds out there's a substantial jump in premium. In calling to find out why, she discovers that her "credit score" is too low, which somehow puts her at an increased risk to have a car accident.

Knowing she's getting into trouble, she decides to stop using the high-balance cards, just pay them off. She also sets out to try to repair her damaged credit rating. On the no-balance cards, she decides to bolster her score by making a small purchase each month, and then paying it off right away. However, she soon finds out that the "grace period" - the time between purchasing an item and when you're charged interest - has shrunk to as little as 20 days. This means that by the time she gets a paper bill, the interest clock may already be ticking.

She vows not to do this again as she mails the payment in. She's going to keep the card at zero, and only use it for an emergency. Lesson learned. Next month, despite having paid her balance in full, she gets a bill with a $40 balance. Puzzled, she reads it through, to find a $40 fee for "late payment." Knowing she mailed the payment in a week before the due date, Jane calls the company to complain. She finds out that while she mailed the payment well before the due date, and it got to the company before the due date, they're still counting it as late because the payment center waited three days to "process" it.

Not only that, but in doing a little research on the web, she discovers there is no limit on the amount a credit card company can charge a cardholder for being even an hour late with a payment:
In 1996, the U.S. Supreme Court in Smiley vs. Citibank lifted the existing restrictions on late penalty fees. Back then, fees ran to $5 or $10, and usually did not exceed $15. After the Court's decision, fees soared, reaching upwards of $30. Since then, the amount of revenue the companies generate from fees (including late charges, over-the-limit fees, and charges for returned checks) has doubled. Duncan MacDonald, one of the lawyers who worked on the Smiley case, predicts penalty fees could rise to $50 in another year.

Learning this, she vows to pay online from now on, rather than trusting the mail. Of course, that costs a $15 "processing fee" instead of a thirty-something cent stamp.

Per card.

Per month.

All in all, Jane discovers that with the new system her card balances have actually gone up, not down, despite her increased payments and decreased spending. Why? Because her interest rates have shot up to somewhere nearing thirty percent. Incidentally, although her income has increased as she had anticipated, gas prices, groceries, and a host of other everyday items that eat a hole in the budget have increased drastically, which makes that raise pretty much a wash.

With all this, she's gone from being basically okay financially, to being one emergency away from bankruptcy. Fortunately, she's still too proud to be one of "those people" who won't pay their bills, so she's determined not to go that route. But if she did the research, she'd find out that bankruptcy's gotten a lot harder, too.

The point is, while many of us are still managing to do okay, there are lots of Janes out there. People who didn't fall for grandiose lending schemes, who didn't charge up a storm trying to keep up with the Joneses, who just followed conventional wisdom and practices and tried to plan as best as they could. And they actually did fairly well . . . for a while. But somewhere in the last five to seven years, the rules changed on them. What was viable in 2002 is a disaster in 2007. They may not be under yet, but they're heading there.

End result: spending is down. Go figure. There are a bunch of people out there who can't make their mortgages anymore. Ya think? Are you seriously surprised that we're no longer in an economic boom? Think about it.

Yes, I'm aware that some lenders did engage in predatory practices. I'm aware that some consumers were stupid and bought way, way out of their price range. But IMHO as a total non-expert, I don't think those people are the majority of the problem right now. The problem is too pervasive. (If there's a study out there that shows otherwise, please forward it and I'll retract that.) Finally, I am also aware that the economy is infinitely more complex than all this, and that corporate issues, natural resource problems, stocks, international trade, and so forth probably play more a part in all this than what's happening to good old Jane. It just seems that all the news outlets talking about the recession are focused on asking why Jane isn't out there spending money, and I thought I'd clue them in.

I also know that it can be ultimately argued that we shouldn't feel much sympathy for Jane. After all, credit cards should never, ever be used. We should all work very hard at being debt-free. In theory, I agree. But while that may be ideal, the reality within which our economy operates is that most Americans do carry some credit card debt. Others advocate that you should use credit cards - particularly now that so much depends on the mighty Credit Score - but that you should use them sparingly always pay your bill off in full each month. Ideally, I agree with that as well. But again, it's not the reality within which our economy operates. Incidentally, you also need to watch out for companies that charge you penalties for payment in full each month because they're so bummed about the loss of all that lovely interest.

Bottom line: If Jane and her peers are really the problem here, can we please stop trying to band-aid this problem by throwing consumers a tax-rebate bone, hoping that somehow the Janes will choose to splurge on a new something-or-another rather than trying to dig themselves out of the hole they're in? That's not realistic. Can we also please stop focusing on the mortgage companies alone, as if they're solely responsible for this mess? If Jane's lack of spending is really the problem here, why not start by re-examining some of the policy changes in the last decade or so that contributed to her budget crunch? Fix some of those, and we might be able to turn this around eventually.

Just a thought.


State 29 believes there isn't actually recession, it's simply election-year spin manufactured by the media. I'm not so sure. On the one hand, I recognize that the media flip-flops on these subjects, and overplays the crisis to sell papers. On the other hand, it seems like the number of people I know in financial difficulties has been steadily increasing over the past few years. Mostly it appears to be due to being stretched from some of the circumstances I mentioned above, and then having a medical crisis, divorce, or some other type of unforeseen problem bring the thing tumbling down. Not that there aren't plenty of people that are doing fine, it just seems this is more common than in the past. So when the media starts pointing the fingers at State's "subprime clowns," I get the feeling there's more to it. So, anybody got the real numbers - statistics to show whether they're right or making the proverbial mountain out of a molehill?

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