The prudent rule that boomers never learned is simple: Don't spend more than
you make.
For a long time, the U.S. economy obeyed that rule...and...it is still in play in some parts of the country, such as Omaha, NE and other farming communities. As far back as the 1960s, personal spending, adjusted for inflation, has basically tracked the overall growth of the economy, as measured by gross domestic product (GNP).
That pattern changed in the 1990s. As of the third quarter of 2007, the 10-year growth rate for consumption was 3.6%, vs. GNP growth for the same period of 2.9%. This difference represents an enormous gap. If consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001.
The question now is how much of that extra $3 trillion we will have to give back?
The limitless spending meme has been socialized in boomers and their children since birth.
In housing and automobiles, consumer affordability is determined by monthly payments, including taxes and insurance.
As higher rates dampen demand for homes and cars, the effects spread to the rest of the economy. More important than housing's direct affect on the economy is the fallout from the slowdown in home-price appreciation. This is where the economy will be most vulnerable. The easy availability of refinancings and home-equity loans have allowed consumers to tap into the equity built up in their homes. The Federal Reserve found that the average household extracted $26,700 in equity with each refinancing. Now the refinancing windfall is going away.
Consumers have been pushed to spend to their credit limits
Lenders, insurers and other financial firms use credit scoring systems to make a host of decisions about consumers, including the interest rate on their mortgages, the limits on their credit cards, and the monthly premiums for their auto coverage. Some rely heavily on FICO, a three-digit score developed by Minneapolis-based financial firm Fair Isaac, while others use proprietary models developed by statisticians.
But credit companies don't disclose what's baked into their formulas, leaving borrowers to wonder which factors determine their financial fate. The FTC suit against Atlanta-based CompuCredit for allegedly "deceptive" marketing practices offers a rare look inside the opaque business of credit scoring. It reveals a mechanism that consumer advocates and politicians have long suspected exists--one in which purchasing behavior, not just payment history, matters.
CompuCredit maintains that the FTC's lawsuit is without merit, and defends its practices. "Every time a consumer accesses their credit, a new decision to extend a loan is being made," says Rohit H. Kirpalani, CompuCredit's general counsel. "These scoring models are commonplace across the industry."
"We as consumers should become aware that behavior is used to determine our credit worthiness," says consumer advocate Karen Gross, president of Southern Vermont College.
My personal credit report places me in the 84 percentile--which is lower than it could be--primarily because I don't spend up to my available credit limits....due to the choice of personal savings versus overspending.
Source: BusinessWeek, June 30, 2008