The Situationist

Archive for November 2nd, 2007

The Financial Squeeze: Bad Choices or Bad Situations?

Posted by The Situationist Staff on November 2, 2007

sharper-image.jpgBob Sullivan wrote a terrific article last month on the sources of pressing debt loads for much of America’s middle class. It reviews and echoes some of the best research on how situational forces are attributed to the dispositions of the individuals and families feeling the squeeze of situation. We have excerpted Sullivan’s article below.

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Shopping malls are packed every weekend. Restaurants can’t open fast enough. Everyone seems to be wearing designer shoes, jackets and jeans and sipping $4 lattes. Credit card commercials constantly advocate splurging and, it seems, U.S. consumers are all too ready to comply.

So what’s the problem? Why do so many middle class Americans with so much stuff say they feel so squeezed? If they are dogged by debt, isn’t it their own fault?

Perhaps, some experts say, things are not as they appear.

Bankruptcy law expert and Harvard University Professor Elizabeth Warren spent a lot of time crunching consumer spending numbers for her popular books, “The Fragile Middle Class” and “The Two-Income Trap.” In both, she makes this point: Despite all those $200 sneakers you hear about and the long lines at Starbucks, consumers are actually spending less of their income — much less — on discretionary items like clothing, entertainment and food than their parents did. In fact, after taking care of essentials like housing and health care, today’s middle class has about half as much spending money as their parents did in the early 1970s, Warren says.

The basics, according to Warren, now take up close to three-fourths of every family’s spending power (it was about 50 percent in 1973), leaving precious little left over at the end of the month—and leaving many families with no cushion in case of a job loss or health crisis.

Warren’s theories fly in the face of conventional wisdom and those crowded malls. But the premise is simple: Even though household incomes have risen about 75 percent from 1970, most of that is the result of a second earner — generally a woman — joining the work force. And that added income has been swallowed by rising fixed expenses, such as child care and housing costs, Warren argues. The average family pays at least twice as much for housing compared to its counterpart in the 1970s, Warren says, and in some competitive areas with good schools, housing costs have risen by as much as 600 percent.

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Now consider these factors: Four in 10 Americans don’t have even one month’s worth of savings for use in case of an emergency, according to a survey by HSBC Bank published in 2006. And with two incomes built into the family budget, the odds of a household getting hit by a layoff have doubled in the last generation. This combination — high housing debt, rising health care costs, lack of savings and greater exposure to unemployment — leaves many families in a precarious financial position.

Yet before Warren can get policymakers to talk about the middle-class squeeze, or at least middle-class worry, she often finds she has to beat back the notion that overconsumption is to blame for the rise in consumer debt — and in middle-class anxiety.

“A growing number of families are in terrible financial trouble, but no matter how many times the accusation is hurled, Prada and HBO are not the reason,” Warren says in her book “The Two-Income Trap.”

There is no arguing that most Americans have more gadgets in their living rooms and more clothes in their closets than ever before. Consider the explosion of the closet-organizer business.

But government spending data paint a different picture. Take the often-cited evidence of culinary extravagance. While it’s true that Americans are eating out much more than ever — nearly half of all dollars spent on food now go to dining out — overall food costs have plunged in recent decades. Americans now spent only about 10 percent of their money on food each year, compared to nearly 20 percent in the 1970s, according to data collected by the Bureau of Labor Statistics.

And despite the designer brands they buy, the average family of four spends about 20 percent less on clothes today, according to Warren’s analysis. Think about your last trip to Target: Thanks in part to the entry of inexpensive imported textiles from China and other trading partners, it’s possible to buy a Friday night outfit for under $40. This shows up in BLS data too: On average, Americans spent nearly 7 percent of their money on clothes in 1973, compared to about 4 percent in 2005.

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In fact, many consumer goods are much cheaper than they were in the 1970s. A look at 1971 Sears catalog offers a glimpse of some plummeting prices. In 1971, a basic Sears refrigerator cost $399. Adjusted for inflation, that would be about $2,000 in 2005 dollars, or nearly seven times the $297 price of a basic fridge in today’s Sears catalog. Put another way, a fridge costs more than two week’s work for an average earner in 1971, but less than two day’s labor today.

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But Amelia Warren Tyagi, co-author of “The Two-Income Trap,” and also Warren’s daughter, said weekend shopping trip receipts aren’t the best way to examine the state of the middle class.

“Yes, people are spending more on home electronics, but the dollars just aren’t that big,” Tyagi said. “Maybe they spend a couple of hundred dollars more on stereo equipment. But they are spending less on tobacco. This is not to say that there’s no frivolous spending going on, but as you add it all up, there’s no more frivolous spending than there was a generation ago.”


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With government data showing that Americans are spending much less than they did 35 years ago on clothes, food, and even entertainment, Tyagi says the anxiety they are feeling comes from somewhere else: the exploding costs of housing, health care and education.

In housing, recent data is most striking. Household incomes have largely stagnated in recent years, even shrinking 2.8 percent from 2000 to 2006. Housing costs skyrocketed 32 percent in that time.

Even more striking is the amount of income most families are paying to stay in their homes. Banks have long had a standard that said mortgages should not be approved unless the monthly payment was 25 percent or less of the buyer’s income. That limitation clearly is long gone. The U.S. Census Bureau defines “house poor” as spending more than 30 percent of income on housing expenses. In 1999, 26.7 percent of U.S. households were considered house poor. By 2006, the number had jumped to 34.5 percent.

. . . . A 1975 Census report showed that only 8.9 percent of mortgage holders spent 35 percent or more of their income — including insurance, property taxes, and utilities — on housing.

The number of households spending half their income on housing — an amount that for most would be fiscal suicide — also has dramatically increased, from 10 percent in 2000 to 14 percent in 2006.


The cost of education has similarly spiked. Pre-school was largely non-existent in the 1970s, but today many families pencil in $1,000 a month for child care and early childhood education. On the other end, college costs have easily outpaced the cost of inflation. For example, the average bill for attending a four-year public college rose 52 percent from 2001 to 2007.

Health care costs have climbed steadily as well. According to the BLS, the average household spent 4.7 percent of its income on health care in 1984, and 5.7 percent in 2005.

In the end, the portion of an average family’s budget spent on fixed costs like housing has risen much faster than wages and inflation, while spending on discretionary items has declined. That means mortgages, more than lattes, are the source of middle-class anxiety, says economist Jared Bernstein of the Economic Policy Institute, a generally liberal think tank that focuses on the interests of low- and middle-income Americans.

financial-squeeze.jpg “Consumers are asking, ‘If the economy is doing so well why am I feeling so squeezed?’” he said. “Well, they feel squeezed because they are squeezed.”

Identifying the source of the squeeze requires more than simply comparing overall inflation to overall wage growth, Bernstein said.

“You have to look at a basket of key goods,” he said, like housing and college costs. “If you compare income growth to growth in prices of key goods, that stuff is growing 10 percent faster than income. … Perhaps (consumers) are beating overall inflation but are they beating inflation in key components of their market basket? No.”

More to the point, Bernstein said, rising housing costs have quietly broken a social contract with consumers that promised that a good job with a good income would guarantee a good place to live. While that may have been true in the 1970s, it is often not true today, he said.

“Lodged in the minds of those who come from the middle class is the idea that the middle class is a safe haven. It’s not,” he said.

That notion is changing. People no longer feel certain they will be better off than their parents, for example. “What really messes with your economic mind is when your expectations and aspirations are violated, Bernstein said. “You think, my parents died in a much better home than they grew up in. Will I?”

Bernstein is not as pessimistic as Tyagi in his interpretation of the data. A comparison of then vs. now needs to be a little more subtle, he said. Clearly, middle class Americans are better off in some ways: larger homes and availability of what were once luxury items, like air conditioning, for instance.

“If a person is arguing that middle class families are worse off in every way, that person hasn’t spent enough time at the mall,” he said. “But these are things you don’t see at the mall: housing, health care, child care, saving and saving for college. The price of those (are) rising more quickly than inflation in general, rising more quickly than family income. And they are largely responsible for the squeeze that families report feeling.”

Middle-class squeeze skeptics often point to rising credit card debt as evidence that consumers have themselves, and their spending habits, to blame for any economic anxiety. But there’s a problem with that theory too — it’s an exaggeration, says Liz Pulliam Weston, author of “Deal With Your Debt” and an MSN Money columnist. The majority of American consumers carry no credit card debt from month to month and very few carry large balances, she notes.

Last year, Americans held about $900 billion in credit card debt, leaving the average household with a bill of about $9,300, according to Federal Reserve data. That sounds like a lot, but a few consumers with very large debts can skew the average. The median balance is — the point at which half of consumers have more debt, and half have less — is a better indicator. The median credit card balance is $2,200, a fairly manageable amount. Only 8.3 percent of households owe more than $9,000 on their credit cards. Meanwhile, one-quarter of all Americans don’t even have credit cards, and another 30 percent pay them off in full every month.

“Our national discussions about consumer indebtedness and bankruptcy are being distorted by the idea that we’re waddling around with four- and five-figure credit card debts,” Weston wrote recently. “That makes us sound like spendthrifts, when that’s not the norm.”

Nevertheless, overconsumption and excessive credit card spending persist as explanations for middle-class debt angst. Tyagi has a theory why.

“Frivolous spending is visible, and it’s easy to pass judgment on, she said. “There is a comforting notion that if you are not spending wildly you are safe. If you are deeply invested in the belief that if everyone can solve their problems on their own, then there’s no systematic problem, it would be important to think that if anyone is in trouble financially it’s because they did something stupid.”

It might be something their parents would never have done, such as taking out a negative-amortization mortgage or taking out a $100,000 home equity loan to pay for a child’s college, or spend as much money on child care as food.

But you can’t blame that on extravagant living, Warren said.

“Perhaps the most important thing we can do is persuade people that it’s not about the lattes,” she said. “I think the “latte factor” is a way to distract people from real changes in the economy. Those who shake their fingers over lattes can feel good about themselves, both for their own economic prosperity and for the fact that those who are in trouble are there because of their own personal failings.”

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For superb blogging on credit, bankruptcy, health-care costs, college expenses, and related challenges to middle-class Americans, be sure to visit Warren Reports. Last month The Situationist published a series of posts on the situational sources of college debt. The first post in that series describes the general ways in which credit card companies have infiltrated college campuses. The second post in this series looks at some of the ways that credit card companies recruit student debtors here. The third post, linkable here, examines the hidden tuition of university credit cards. The fourth in the series examines some of the steps lawmakers are taking to curb the the most egregious strategies of credit card companies.

To watch the acclaimed, eye-opening documentary “Maxed Out” (1 hour, 27 min), click on the Google Video below.

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