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King Kong debt meets middle-class life

In a generational shift, Americans have come to accept big credit-card balances as inevitable. First of two parts.

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What is clear is that high debts have made consumers less likely to serve as the engine that drives the economy and more vulnerable to an external shock. The most vulnerable are the poor.

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Consumers have borrowed to the point where they won't be able to go on a "borrow-to-spend binge" that could spur economic growth in the next few years, says Scott Hoyt, director of consumer economics at Economy.com. Also, if there's an economic shock "instead of just a temporary slowdown in economic activity, [the debt burden could] tip the scales and turn it into a full-blown recession."

That's not something he foresees happening. Other economists do.

What's important to watch, economists agree, is not today's record level of red ink but rather the debt burden - the portion of disposable income used to pay mortgages and consumer loans (known as the debt service ratio). In the first quarter of this year, that ratio stood at 13.0 percent. Since 1980, the ratio has fluctuated between 10.6 and 13.3 percent.

For most Americans, debt remains a manageable means to an end. The vast majority of it is connected to paying for a home, college tuition, a small business, or a car for commuting to work.Typically, such debt is insulated from short-term swings in interest rates.

But debt also can be overwhelming, especially for the poor. Of those households in the lowest income bracket, 27 percent have to devote $4 of every $10 in take-home pay to debt payments. In the general population, only 11 percent of households have to devote so much income to debt, according to an analysis by the Federal Reserve Board.

More controversial is the surge in credit cards. On the plus side, credit is now more easily accessible for a diverse cross-section of Americans than it was in the 1960s. The expansion has enabled more people to finance large purchases and even entrepreneurial ventures.

More than 190 million people now carry credit cards, according to research firm CardWeb.com. For the 40 percent who pay off their bills in full each month, the cards are a matter of convenience and rewards such as frequent-flier miles. They're part of the reason that outstanding consumer credit - the portion of debt not secured by real estate - topped $2 trillion for the first time this year.

But for the 60 percent who don't pay off their balances monthly, debt burdens can mount quickly.

In fact, credit-card balances carried by the poor have grown at a faster clip than any other income group. Between 1989 and 2001, households with incomes under $10,000 that carried credit-card balances saw those balances rise 184 percent, compared with a 53 percent increase for all income levels combined.

Tremendous growth in subprime lending in recent years has also given access to credit to many consumers who need it and manage it well. But critics charge such lending involves "predatory" practices - everything from aggressive marketing to high penalty fees buried in the fine print.

"Although credit [terms] are supposed to be risk-based, lenders are charging more than the applicable risk" to people such as minorities, the elderly, and low-income families, says Karen Gross, a consumer-debt specialist at New York Law School.

Even for families who are relatively disciplined about their spending, mounting debt can be hard to avoid. The average dual-income family's discretionary income after paying for fixed expenses - such as child care, health insurance, mortgages, and taxes - is slightly less now than it was for one-income families in the early 1970s, according to a report by The Century Foundation in New York.

Entire communities can feel the ripple effects of heavy debt - if there's a rash of home foreclosures, for instance. But because the growth in subprime lending is a relatively recent phenomenon, it's hard to predict what it will mean for the economy as a whole, notes Professor Gross.

"It's a new world with new borrowers, and where and when the system sort of overstresses, I don't know," she says.

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