By  on October 16, 2006

American consumers are racking up debt at an increasing rate, and retailers at all price points could soon start to feel the pinch.

Overall, consumers have $2.35 trillion worth of outstanding debt of all kinds, according to statistics from the Federal Reserve Board. In the aggregate, U.S. households shelled out 13.93 percent of their disposable income during the first quarter to cover mortgage and consumer debt payments, according to the Fed. That's up from 12.88 percent five years ago and 11.86 percent 10 years ago, indicating an acceleration, though the numbers also go up as home ownership increases.

Economists and other analysts differ over how dire a problem consumer debt is and whether the country is looking at a credit crunch with wider fiscal implications in the near future. One thing they can't deny, though, is that consumer spending has been the engine of the U.S. economy over the last 35 years. Any slowdown in expenditures would have significant implications for the overall economy.

And despite concerns over debt, inflation, softening house prices and the trade deficit, Wall Street seems unfazed — the Dow Jones Industrial Average hit a record high Friday of 11,960.51, its sixth record in two weeks.

In addition, most observers remained relatively optimistic about the upcoming holiday season, predicting sales would rise by 5 percent to 7 percent during the period.

And how will many Americans pay for these gifts? With credit, of course.

"We've been in a debt crisis," said Mary Beth Pinto, director of the Center for Credit & Consumer Research at Penn State Erie's Behrend College. "This problem that a lot of Americans face is not getting any better."

Pinto said there is a "blurring between a luxury and a necessity" and a need for financial education at a young age.

"There are 10 [percent] to 15 percent of households who are really living on the edge," said James F. Smith, director of the Center for Business Forecasting at the University of North Carolina at Chapel Hill. "They've got an awful lot of debt in relation to income, and it wouldn't take much — an illness, a divorce, a death, a loss of job or cutback in hours — to throw them over the edge."These people living on the edge don't pose a significant risk, he said, noting there has never been a recession caused by consumer indebtedness.

"It's a microeconomic problem, not a macroeconomic problem," said Smith. "If you're on either side of the credit counseling desk, it's a big problem."

The increase in consumer debt relative to income since the mid-Eighties is the product of declining interest rates, as well as regulatory and tax-code changes, said Christian Weller, senior economist at the Center for American Progress, a progressive think tank.

"All households are taking on debt, but it is most pronounced in the middle-income categories," said Weller. "The sharpest increases are obviously for home spending."

In addition to increasing debt, consumers are threatened by slowing income growth and higher interest rates, which could severely affect people with variable rate mortgages, he said.

"That triple just squeezes out other spending or families are worried that it's going to happen, and they're just going to pull back in anticipation," said Weller.

Areas that consume a lot of household dollars, like energy and health care, have also had big price increases, further squeezing budgets. While gasoline prices have declined in recent weeks, they remain well above last year's levels.

Unlike other economic factors, such as increases in gas prices that hit the hardest people who make the least, indebtedness can also hurt people at the higher end of the income spectrum.

"I worry more about the aspirational customer," said Deborah Weinswig, an equity analyst at CitiGroup. "That consumer might have been stretching up and buying a designer handbag when they hadn't in the past, just consuming beyond their means."

For many, the impact of higher payments on home mortgages is one of the gravest concerns.

The exposure people have to adjustable rate mortgages could ultimately have an impact on the economy, said Robert Manning, a professor at Rochester Institute of Technology and consumer debt expert.

"Those areas that had the sharpest [home] price appreciation are going to have the sharpest readjustment, and that's going to have a sharp impact on people's attitudes toward credit and debt, and part of the whole issue about consumer spending is one's optimism about the future," said Manning.Housing prices rose dramatically in areas such as Chicago, Washington, D.C., South Florida and New York, he noted. But the housing market, which helped boost the economy after the tech bubble burst, has cooled dramatically in recent months; the number of new one-family homes sold in August dropped 17.4 percent year-over-year to an annual rate of 1.1 million, according to the Commerce Department.

The Fed in August ended a two-year campaign of 17 consecutive increases to its benchmark federal funds interest rate, which now stands at 5.25 percent. The Fed uses that rate as a tool to fight inflation, but many economists now think the economy is slowing enough to keep prices in check and still see no new rate hikes in the immediate future.

The Fed funds rate determines how expensive it is to borrow money for everything from a home to a dress or a college education. It is the breadth of credit available that gets some of the blame for consumers getting in over their heads.

"It's mortgage debt, it's student loans and it's credit card debt — it's the whole picture," said Deanne Loonin, staff attorney at the National Consumer Law Center, an advocacy group for low-income consumers. "The levels of debt in and of themselves are alarming. It is very alarming that when people start to get into a little trouble, the consequences spiral very quickly."

So far, easy access to credit does not seem to have had a big impact on retailers, since consumers haven't curtailed their spending. The Commerce Department on Friday said sales at apparel and accessories stores shot up 10.7 percent in September versus a year earlier, driven in large part by lower gas prices and cooler weather.

"They seem very active in the stores, month after month," said Janet Hoffman, managing partner of Accenture's North American retail practice. "They may be going further into debt in doing all their shopping, but they're out there shopping."

Retailers have long dabbled with offering their customers credit, though most stores avoid exposure to the back end of the business, relying instead on third parties. For stores, credit cards offer a branding opportunity and a chance to get a peek at consumers' shopping habits, especially cards co-branded with Visa or MasterCard."It is an increasing part of the business, and it's very advantageous for the retailer to have the credit card," said Hoffman, who noted that stores can pick up lots of consumer shopping information through their credit card programs.

Retailers' gleaning intelligence from credit card statements might be a relatively new aspect of extending credit, but the practice of taking home goods without paying up front has been around for a long time and will likely endure.

"Turn back the clock 150 years and people lived on credit maybe more than they do right now," said Lendol Calder, associate professor and chair of the history department at Augustana College in Rock Island, Ill., who has studied the history of credit. "They got it from pawn brokers…loan sharks, they got it from retailers. Americans go into debt because they're pretty optimistic about their ability to repay it."

Still, some economists see the current indebtedness as a trend with limited implications for the broader economy. It seems that as long as Americans have used credit, people have predicted some disastrous fallout that has yet to occur.

"The story of the boy who cried wolf is the perfect story for this, because in that story, he loses all credibility," said Calder. "But the wolf does come eventually, and that could happen. We just don't know. Nobody knows at what point too much debt is too much."

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