Savings accounts are depleted as credit card debt increases

The savings rate in the United States dropped last year to the worst rate since the Great Depression of the 1930’s. To call it a “savings rate” is a bit misleading; Americans actually “saved” a -0.5 percent. In truth, there were no net savings at all. We spent it all, and then some. The notion of saving money for a “rainy day” has long been instilled in the American work ethic, but declining salaries and rising home prices have made it harder for people to save as they struggle to buy their houses at prices that are at historic highs.

That, combined with the added convenience of paying by credit card, has led many people to living beyond their means. It is easy to do; the minimum credit card payments are only about 4% of the balance. You can go out today and buy a $1000 television set, knowing that when the bill is due the credit card company will only ask you for $40. Why not?

This sort of high living has been spurred on by the dramatic rise in real estate prices. People in existing homes have been astonished to see how much their equity has increased. When you buy a home for $200,000 and you find that it has a market value of $500,000 just five years later, why worry about saving money? The house can do it for you! People have responded to that not by saving their equity and appreciating their gains, but buy taking out home equity loans in record numbers. They have been using the money to buy cars, other houses, dream vacations and whatnot.

That could create a lot of trouble now that the market for real estate seems to be peaking. Interest rates are beginning to rise and that makes houses less affordable. Given that they haven’t been affordable for quite some time, the sale of homes is slowly dropping. And as the sales drop, so will the prices, reducing the equity that people have in their property.

And when the equity drops, people will find that the wave of free money they were getting from their houses is drying up.

It is hard to predict what will happen to the economy as a result of these changes:

• A rise in interest rates.
• A decline in savings to less than zero
• A decline in home values
• A decline in home sales
• An increase in the need for debt consolidation
• An increase in the minimum required credit card payment

These things could combine to create yet another recession, as people find they cannot afford to buy houses and cannot afford to pay existing bills. This will hurt people who have property to sell, some of whom may have to sell at a loss. While it is hard to say whether this “doomsday scenario” will play itself out, this much is certain - failing to save money for the long term is a shortsighted mistake.

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