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Business Daily The tireless American consumer has foiled pessimistic economic prognosticators for decades. And while there's no reason to expect that to change, there is reason to expect consumers will have to start living within their means. After two decades of downtrending interest rates, the Federal Reserve's next move is almost certain to be a hike, not a cut, from the 45-year low of 1%. With households paying a near-record share of disposable income to service debt despite rock-bottom rates, they'll be hard-pressed to spend more than they earn as borrowing rates climb, some experts say. And if households decide to raise their historically low savings rate, that could mean that spending will grow slower than incomes. While not dire, the outlook highlights the need for job and income growth to keep consumer spending on the rise. But last year's tax cut, which will lead to big tax refunds this spring, gives the economy some breathing room. "The starting point of this expansion is very different from that in the last one," wrote Jason Rotenberg, an analyst at investment manager Bridgewater Associates. "Falling savings rates and rising debt levels flow directly to stronger growth, and at the very least they are unlikely to be repeated" in this cycle. Consumer Debt At High Level In second-quarter 2003, household debt service payments came to 13.3% of disposable personal income, according to Federal Reserve data. That's near the record 13.58% set in late 2001, and far above the mid-1993 level of 10.78%. The steady rise in debt payments has come even as rates have steadily fallen, with 10-year Treasury yields down to about 4% now from about 8% in late 1994. Much of the rise is due to a greater level of home ownership and associated mortgage debt. But other debts, such as credit cards and auto loans, have soared to just under $2 trillion in November, up from $850 billion a decade earlier. Households have taken advantage of decades-low rates to refinance their homes and lower overhead. They've also been able to cash out some equity from their homes, thanks to soaring home values, and pay off credit-card debt. Still, debt service has gradually been rising. A broader Fed gauge, known as the financial obligations ratio, adds auto lease payments, rent payments, homeowner's insurance and property tax to household debt service. In the second quarter of 2003, household financial obligations equaled 18.09% of disposable income, up from 16% a decade earlier. "It has taken steadily falling interest rates to offset a steadily rising debt burden," wrote The Levy Economics Institute. "Interest rates are now at historic lows and cannot perform this compensating function any longer. Even if interest rates were to merely remain constant, the debt service burden would rise as fast as the relative level of debt itself." Levy economists conclude, "The rate of increase of new debt, and hence the rate of consumer spending, is therefore likely to slow down." A significant rise in interest rates could exacerbate the problem. "The consumer hung tough during the last major Fed tightening cycle in 1994, but in the intervening decade consumer debt has grown from 85% of annual income to 115% of annual income," wrote Ethan Harris, chief U.S. economist at Lehman Bros. Ian Shepherdson, chief U.S. economist at High Frequency Data, argues that "fears of a debt-constrained recovery are overdone." He noted household assets have risen much faster than liabilities in the past decade, thanks to stock market gains and rising home values. "Over the next couple of years, the cyclical upswing in spending will be more muted than would have been the case had the (financial obligations ratio) remained at its early '90s level, but that does not mean spending growth has to be absolutely slow," Shepherdson wrote. Levy Institute President Dimitri Papadimitriou noted that falling interest rates have been a key factor propelling stock and home values, so higher rates could hurt the asset side of consumer balance sheets. That asset growth has given consumers the confidence to borrow more and save less, he said. He also said fast consumer debt growth has been replaced by growth in federal government debt, which is also approaching an unsustainable level. Steven Wieting, senior economist at Citigroup, said growth in consumer spending has typically cushioned the economic downturns and restrained the upturns, noting that nominal consumer spending hasn't fallen since 1938. "That's why they're called business cycles," not consumer cycles, because business spending is much more volatile, Wieting said. Since inflation has been muted and hasn't robbed consumer purchasing power, there won't be a rebound in consumer spending like there was in the early 1980s, he said. "Consumers will probably spend at their income growth," Wieting said, noting disposable income this year will get a nice boost from big tax refunds. Back to Original Article: Mortgage News You Can Use
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