HEATHER ANDERSON ruefully admits that she should have known better. A veteran of nearly two decades in the credit-union industry, she had spent her career warning would-be borrowers about the perils lurking in home-equity loans, bells-and-whistles mortgages, and the seductive fantasy that debt was interchangeable with wealth. But the housing boom was roaring ahead, and “I started to feel left out,” Anderson recalled. So in 2005, she and her boyfriend bought a house in San Diego with a no-money-down, interest-only mortgage and a home-equity loan.
Less than a year after the couple moved in, they broke up. Unable to sell the house, even at a loss, and ground down by the strain of living with her ex, Anderson moved out, although she kept up her share of the mortgage payments. “I had to,” she said. “My credit score was my safety.” But her sacrifice was in vain. Her former boyfriend moved out as well, leaving no forwarding address for the mortgage company. Unable to persuade her lender to renegotiate, Anderson, now 41, watched helplessly as the house slipped into foreclosure, dragging her credit score down with it. When the interest rate on her sole credit card jumped 50 percent in a month, she started paying for all her purchases in cash.
What followed took Anderson by surprise. Instead of the unrelenting anxiety she expected as her income and credit rating went into a free fall, she felt relieved. It wasn’t just that she no longer worried about scraping together enough cash to pay the monthly mortgage. It wasn’t only the satisfaction she felt as her credit-card balance went into remission. It was the serenity she felt after she unplugged from the consumption economy’s machinery of desire. Anderson had canceled her cable-television subscription after moving out of her house, and, without the constant din of commercials hawking the next must-have kitchen gadget and the fashion tips that left her itching to update her wardrobe, she found herself with ample time to launch a sports-jersey business—financed without credit, of course. No longer tempted to roam the mall in a fog of hankering, Anderson felt a newfound clarity about what really mattered in life. “Instead of consuming in my spare time,” she said, “I started producing.”
Millions of Americans are taking similar steps. Some 8 million U.S. consumers stopped using bank-issued credit cards in 2010, according to the credit-reporting agency TransUnion. The average credit-card balance has fallen 10 percent this year from 2010, to $6,472; U.S. consumer debt has dropped for 12 consecutive quarters, from a peak of $14 trillion in early 2008 to $13.3 trillion last spring, mainly because of mortgages repudiated or abandoned. People are cutting visits to the hairdresser, buying used cars without financing, and living on surplus cheese as they trudge toward the promised land of a debt-free existence.
Suppose everyone did what Heather Anderson is doing? And that the federal government, just as virtuously, did the same? And Europe too? What if everyone deleveraged at once? Guess what—that is exactly what’s happening in the wake of the Great Recession. For better or worse.
Ponder what economists call the paradox of deleveraging. This occurs when economic actors on all sides—consumers, business, government—all retire their debts at once. Unless their incomes are rising, they can pay off debt only by cutting what they spend. This, in turn, reduces the demand for goods and services, which drives prices down, further trimming businesses’ revenue and thus their ability to pay employees, who in consequence spend less. The cycle continues, until incomes fall so low that there’s no longer cash available to reduce the debt. And as incomes and business profits decline, so do government tax receipts, resulting in fewer police officers, more unfilled potholes, and greater pressure on pensioners.
A deleveraging nation, economists say, risks higher unemployment and years of subpar economic growth and could trigger a deflationary spiral in which consumers forgo spending, anticipating lower prices in the future. “When economies are deleveraging,” Atlanta Federal Reserve Bank President Dennis Lockhart said in a recent speech, “they cannot grow as rapidly as they might otherwise.”
Ye gods, what to do?
Economists offer two (or more) contradictory answers. Keynesians believe that government can break the downward spiral by borrowing money and injecting it into the economy, replacing the income lost when jobs disappear and consumers don’t spend as before. The government-driven uptick in demand, the thinking goes, instills confidence that economic activity will pick up, spurring hiring and giving consumers the means to spend while paying down their debt. Once the economy starts to grow faster than the government’s borrowing, the debt will decline as a percentage of economic output.
This article appears in the October 14, 2011 edition of National Journal Magazine.
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