WASHINGTON, Aug. 19 (UPI) -- One of the features that will make the second "dip" in this recession much nastier than the first will be a tsunami of consumer bankruptcy such as we have not previously seen, which will alter the U.S. economic landscape for a long time to come.
Personal bankruptcy has not been a feature of past recessions, since World War II. In the 1980-82 recession, annual personal bankruptcy filings peaked at 315,818 in 1981. In the 1990-92 recession, after the debt expansion and high interest rates of the 1980s, things were considerably worse: bankruptcy filings peaked at 900,874 in 1992.
That peak had already been exceeded during the mild slowdown in 1998, with a total of 1,398,182 personal bankruptcies. However, the 2001 total exceeded this, at 1,452,030, more than four times the 1981 peak. The second quarter of 2002 set a new record, at 390,991 non-business bankruptcies, a total that would give 1,564,000 if repeated through 2002.
In short, in spite of interest rates far lower than in the 1980s, the levels of personal bankruptcy are very much higher. Indeed, annual bankruptcies are now double the level of the entire decade of the Great Depression.
Of course, the major reason why personal bankruptcy filings are so much higher now than in the 1930s is that the law has changed.
In 1978, Congress made it hugely easier for individuals to declare bankruptcy and thereby to rid themselves of the most of the burden of their excessive unsecured debt. In addition, under the 1978 law, a primary residence was not subject to bankruptcy seizure, another loophole that has enabled many wealthy people to escape from their creditors with McMansions intact.
It is likely the 1978 change in the law was itself partially responsible for increase in bankruptcy filings, but not for the overall change in consumer borrowing behavior we have seen in the 1980s and 1990s.
According to Federal Reserve Board statistics, consumer debt rose only gradually as a percentage of national income in the 50s, 60s and 70s.
It reached 11.77 percent of gross domestic product in 1982, at which point revolving debt (credit cards) was 17.3 percent of total consumer debt. Consumer debt then rose to 14.26 percent of GDP in 1987 but fell back to 12.38 percent of GDP in 1992, by which time revolving debt represented 35.6 percent of total consumer debt.
The real take-off occurred, as one might have expected, in the 1990s. In the five-year period covering 1992 to 1997, consumer debt rose from 12.38 percent of GDP to 14.94 percent. However, in the period 1997-2001, instead of declining as it had in previous recessions, consumer debt rose further to 16.54 percent of GDP, with credit card debt in 2001 representing 42.0 percent of the total.
In terms of saving, too, the 1990s were anomalous. The lowest savings rate since World War II, until 1997, was the 4.7 percent of personal income of 1947, in a postwar boom that followed several wartime years of high forced saving.
In the 1950s through the 1980s, the savings rate never dropped below 6.9 percent. After the 4.2 percent of 1997, and a slight up-tick to 4.7 percent in 1998, the savings rates in 1999-2001 were 2.6 percent, 2.8 percent and 2.3 percent.
Like stock prices, consumer debt reached unprecedentedly high levels in the late 1990s, while personal saving dropped far below any level seen since the Great Depression. Like stock prices, these trends are likely to regress much closer to the norm in the near future.
The higher savings rate will cause consumer spending, which has been the economy's main prop for two full years now, soon to become a drag on economic recovery, as consumers retrench to save enough to pay bills and fund retirements that the stock market's drop has left uncovered.
The higher consumer debt level almost certainly has to produce a higher level of bankruptcies in years to come, although two extraneous factors will affect this outcome.
The first is the overall level of interest rates, and liquidity generally.
The second is the fate of the Bankruptcy Reform Act, currently awaiting the Senate's return from vacation and likely to reach the president's desk for signature within the next few weeks.
The fall in interest rates over the last few years has been a highly stimulating factor for consumer spending. By reducing mortgage costs, it has produced a sustained rise in house prices, far above the level of inflation, which has greatly mitigated the negative wealth effect from the stock market's decline. In addition, by encouraging mortgage refinancing, it has provided additional cash to stimulate further consumption.
Even a bottoming out of interest rates is likely to cause a fall in consumption, because of the ending of the house price rise and mortgage refinancing effects. However, with indices of inflation showing an upward trend recently, in spite of declining commodity prices, it is likely that the current exceptionally low level of long-term interest rates will be sustained only if there is a truly disastrous recession, with accompanying fall-off in demand.
The Bankruptcy Reform Act, by making it more difficult for consumers to evade their obligations through declaring bankruptcy, is likely to have a substantial dampening effect on consumer spending, particularly in low- and moderate--income families. Nevertheless, this effect will not appear rapidly, since consumers will need to gain experience of the new act's effects, and adjust their buying patterns accordingly.
By introducing such legislation in an economic downturn, however, Congress runs the risk of hastening the consumer's return to traditionally higher savings rates, and thereby prolonging and deepening the recession.
Further, it is likely that, with low- and moderate-income families having been encouraged by the credit card companies to take on wholly excessive levels of consumer debt, the social effect of more difficult bankruptcy may be severe, with many cases of genuine and photogenic hardship.
Much better, if Congress wants to curb irresponsible credit card borrowing, and prevent the deterioration in banks' balance sheets that it is causing, is for it to pass legislation severely limiting the marketing of credit cards, and the percentage of consumer income that can be granted as card credit limits.
The convenience of credit cards, in moderation, is such that they should be available to all. The dangers of excessive credit card limits, to both the consumer and, in the long run, to the card issuer, are such that the facility should be severely limited, particularly in the case of low- and moderate-income families.
It is often said that the decline in stock prices will not affect U.S. consumers greatly, because stock ownership is concentrated among the wealthier families (even though 50 percent of consumers own stocks, directly or indirectly, their ownership amount is in many cases quite small.) This is not, however, the case with credit cards.
Excessive credit card issuance has been common at all income levels, and if issuers now want their money back, and will not allow consumers to slide out of their obligations through bankruptcy, the depressing effect on U.S. consumption is likely to be severe indeed.
Yet another reason, and a very powerful one, to remain bearish about prospects for the U.S. economy in the next few years.
(The Bear's Lair is a weekly column which is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long 90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent, and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
