Consumers Are Climbing Out of Debt

We've had a couple of days to return the unwanted and unthinkable. Retailers and economists are now trying to determine what sort of holiday shopping season this was - as well as what it may portend for the future.

The big news, as the following article makes clear, is that Americans have been paying down the debts that fueled the pre-financial crisis bubble. And the deleveraging is significant, almost a 30 year low.

Some of this has to do with the foreclosures, short sales and repossessions that cratered the real estate market. But some has to do with a more disciplined approach to spending, credit card debt being the primary culprit.

This may have contributed to a more robust holiday sales season than anticipated. And it may suggest that both consumers and businesses are learning to live, profitably, with a less inflated but more realistic economy. JL

Ben Casselman reports in the Wall Street Journal:

American workers haven't seen their incomes grow much since the recession ended more than three years ago, but they do have something to show for the recovery: Household debt payments are at their lowest level in decades, which is helping paychecks stretch further U.S. households spent 10.6% of their after-tax income on debt payments in the third quarter of the year, the lowest level since 1983, according to recently released Federal Reserve data. Add in other required payments that aren't classified as debt—such as rent and auto leases—and the figure rises to 15.7%, also near a 30-year low.

Debt payments are being pushed down by a variety of factors. After borrowing heavily during the housing boom, many families have devoted much of the past five years to working off debts and rebuilding savings. Not all such deleveraging has been voluntary. Foreclosures and bankruptcies have played a major role in reducing household debt, while tighter lending standards have made fresh borrowing difficult for many people.

But for those who do qualify for loans, record-low interest rates have made it far cheaper to buy a car or house and have allowed millions of families to refinance their mortgages, often reducing payments by hundreds of dollars a month.

Home prices are finally rising again in parts of the country, which could open the door for thousands more to refinance in the months ahead.

Falling debt payments are helping prop up consumer spending at a time when unemployment remains high and wages are barely keeping up with inflation. Consumer spending has risen 7.7% since the end of the recession in mid-2009, after adjusting for inflation, compared with a 5.3% increase in incomes.

Paul Ashworth, chief U.S. economist for research firm Capital Economics, said falling debt payments are significant for the economy because the middle-income families who are most likely to owe money on credit cards or car loans are also the ones most likely to increase spending whenever they get some extra room in their household budgets.

"For every dollar they save on servicing their debts, they will probably go and spend that money elsewhere on other goods and services," Mr. Ashworth said.

Lance and Julene Lambert have spent much of the past three years repairing their household finances. They paid off their credit-card balances and car loans and last month refinanced the mortgage on their Austin, Texas, home, a move that saved them $500 a month. Mr. Lambert, a 42-year-old information-technology manager, said the moves will help maintain their standard of living even though his wife, a real-estate agent, plans to cut back her hours to stay home with their month-old daughter. And after the trauma of the financial crisis, Mr. Lambert said he feels more secure knowing he has reduced his financial obligations.

"As a response to the recession, my wife and I really put our focus on paying down debt," Mr. Lambert said. "We wanted to find opportunities to lower our monthly costs."

Not everyone has been able to cut back their payments. Still-depressed home prices and strict lending standards mean many homeowners don't qualify to refinance. Rents are rising, pushing up the share of renters' income that goes to required financial obligations to 24.1% in the third quarter, the highest level since early 2010, though it remains well below prerecession levels.

Looming on the horizon is the fiscal cliff, billions of dollars in tax increases and government spending cuts due to take effect at the beginning of the year. President Barack Obama and congressional leaders are still trying to find a way to avoid the cliff, but any deal is likely to result in tax increases for at least some Americans.

But other factors are working in consumers' favor. Inflation remains in check, and gasoline prices have fallen more than 50 cents a gallon in the past two months.

Ram Bhagavatula, an economist at investment firm Combinatorics Capital in New York, said the long, painful process of repairing household balance sheets is nearing completion. At the peak of the housing boom, nearly 19% of households' after-tax income went to debts and other required payments. Now below 16%, the so-called financial obligations ratio has at last returned to a more sustainable level, he said.

"In some sense the underlying problem has been fixed," Mr. Bhagavatula said.

Lower payments don't always translate into higher spending for debt-leery households, however. Josh Penland, a mortgage banker in Austin, Texas, said many of his refinancing clients are using their savings to pay off other debts, or in some cases even refinancing to shorter 15-year mortgages that don't reduce their payments but let them pay off their loans more quickly.

"I think there's an emotional piece to seeing the balance being paid down," Mr. Penland said.

John Miller and his wife recently refinanced the mortgage on their Buffalo, N.Y., home, shaving $400 off the minimum monthly payments. But rather than spend the extra money, Mr. Miller, a 42-year-old computer consultant, said he and his wife are continuing to pay at their old rate in order to work off their loan in less time. That means their decision to refinance will do little to boost the economy in the short term, although it could lead to an increase in spending down the road.

"We'll probably eventually go for getting extra money in the budget when we need to buy a new car or something like that," Mr. Miller said. "But we figured we're not missing the money right now."