New era of austerity for U.S. borrowers?

Record levels of debt and falling home prices may mean Americans will now spend less, save more.

from the December 27, 2007 edition

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The problem: Bad news tied to the housing market may not be over – and could make the debt workout tougher on banks and consumers.

In the recent housing boom, homeowners generally saw the value of their dwellings rise, but they took on a lot of debt in the process.

Rising home prices pushed up their net worth. But consider the debt side of the ledger alone: Borrowed funds now equal 138 percent of annual household income, according to Federal Reserve data tracked by the investment firm Merrill Lynch.

Until 1990, this figure usually stood below 80 percent.

"Excessive debt is a problem that encompassed the full spectrum of households," David Rosenberg, chief economist at Merrill Lynch, writes in a recent report. Now, thanks to the housing downturn, "we are at the early stages of savings revival," he says.

A higher savings rate not only will help consumers repair their household balance sheets, but it also helps the whole economy, some analysts say, because the nation then has to borrow less money from abroad to invest in new jobs and equipment.

The downside, however, is less money for consumer spending.

That was visible during this holiday shopping season. Retail spending rose but at a slower rate – and much of it was financed by a fling with credit cards that may not be sustainable in the new year.

On Tuesday, MasterCard Advisors reported that US holiday sales were 3.6 percent higher than in 2006, a more tepid gain than the 6.6 percent rise the year before.

As holiday spending began in November, the personal savings rate turned negative. But with home prices no longer rising and banks tightening up on their willingness to lend, economists say that return to positive savings is likely.

The good news is that, on average, households have more assets than debts – a positive net worth.

But signs of borrower stress go beyond subprime home loans. About 4.5 percent of auto loans made in 2006 to top-rated borrowers were at least 30 days delinquent as of the end of September, up from 2.9 percent the previous month, according to a Lehman Brothers survey cited by the Associated Press. Credit-card loan losses are also rising.

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