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Marketplace Scratch Pad

Debt destruction

Scott Jagow Mar 12, 2010

A new Federal Reserve report says total US household debt fell in 2009, the first drop since records began in 1945. But before anybody gets too excited, we have to consider how this debt is being destroyed.

From the Wall Street Journal:

The drop reflects the extent to which job losses and a moribund housing market are forcing people to default on mortgages and other obligations, a painful process that has slammed millions of families and hit banks and investors with hundreds of billions of dollars in losses.

At the same time, the defaults are leaving many people with more cash to spend and save, jump-starting the financial rehabilitation, or “deleveraging,” that economists see as a crucial prerequisite to robust growth.

People are defaulting their way out of debt, not climbing out of it. A similar thing is happening with credit cards. Odysseas Papadimitriou, the CEO and founder of CardHub.com, concludes that most debt reduction consists of “charge-offs” by credit card companies, rather than people actually paying it off. Wallet Pop gives three reasons for his skepticism.

  1. Credit card issuers raised rates “extremely,” meaning that more and more of a consumer’s payment would go toward paying interest rather than paying down debt.

  2. Record unemployment rates, which means fewer consumers can afford to pay down debt.

  3. Record bank losses.

“From my experience, when consumers pay more, their finances are healthy,” Papadimitriou said. He also added that we were seeing “record losses from the banks. That doesn’t go hand-in-hand with credit card payoff.”

Whatever the means to lower household debt, the end should be more flexibility. Debt reduction should pave the way for a more robust economy. But we’re at a crucial stage here. It’s dangerous when people have their debts eased or wiped away without serious consequences. But it’s good to see signals that some people have learned from their experience. The Journal talked to a family who did a short-sale to get out from under a mortgage and is now paying down their credit card debt:

With a pretax monthly income of about $6,000, the Browns can allow themselves some luxuries. But Mr. Brown said they are using nearly a third of their income to pay down about $38,000 in credit-card debt they had built up doing things like taking their grandchildren on trips to Disneyland. After that, Mr. Brown hopes to save enough to purchase another house.

“On one hand it’s a relief” to have less debt, he said. “On the other it’s sad that we let ourselves get into this situation, individually and as a society.”

Speaking of that, the government’s debt picture looks much different than household debt. From the Atlantic:

State and local governments borrowed a fresh $109 billion during 2009. The federal government borrowed $1.4 trillion. That’s more than the $1.2 trillion borrowed in 2008, and nearly seven times the borrowing of 2007. That’s also a full trillion-plus more dollars of borrowing than in any year other than 2008.

The federal government better start getting its house in order, too.

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