The Case for Debt

Through good times and bad, Americans predictably rack up consumer debt, and that debt predictably generates public and private hand-wringing about how it will ever get paid.

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…on closer examination, what looks like “unprecedented” consumer indebtedness turns out to have ample precedent, as do the anxiety and moralizing that accompany it.

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The expansion of consumer credit is one of the great economic achievements of the past century. One institutional and technological innovation after another has made borrowing easier and cheaper for rich and poor alike. With each development have come fears—sometimes fueled by the unforeseen problems that inevitably accompany new practices—that this is the change that surely will lead to disaster. Yet a half century after [Hillel] Black’s warnings, doomsday has not arrived, the “consumer-credit explosion” continues, and most consumers are much better off.

Gone are the up-front fees and intrusive interviews that used to be standard before taking out personal bank loans or establishing store credit. Except for those offering airline miles, most credit cards no longer have annual fees, while intense competition for new customers—think of all that annoying junk mail—has driven down the average interest rate, from 17.4 percent in 1992 to 13.1 percent in 2007. Today’s consumer credit is flexible, convenient, impersonal, and (excluding car loans and mortgages) largely unsecured. With a credit card, you can rent a $40,000 automobile, buy goods online from complete strangers, finance a business, make ends meet while you’re out of work, purchase a $5,000 wedding gown or a 10-cent photocopy—all without completing any forms or explaining yourself to anyone. And despite recent legal revisions, even bankruptcy is less painful than in the days of buying on time. If you default on your Visa bill, nobody comes to repossess your refrigerator or auction off your shoes. The biggest penalty you’ll face is trouble getting future credit.

So why do we worry so much? For starters, the very success of consumer credit makes us uncomfortable. As borrowers, we may feel guilty about running up debt, anxious about making payments, and resentful of the constraints that old obligations (and old credit records) impose on our current choices. We may find it too easy to buy things we may later regret. In theory at least, we might prefer the days when paternalistic—or snobby—salesclerks checked our spending.

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When credit is cheaper to use and easier to arrange, people do use more of it. Hence those big, scary numbers, which grow along with the economy and the population. Contrary to a common perception, however, the people driving up the totals aren’t primarily the financially strapped. They’re “high-wealth consumers in their prime earning years,” observes Andrew Kish, an economist at the Philadelphia Federal Reserve. Almost half the growth in debt between 1989 and 2004 (the most recent year for which data are available) came from the highest-income 20 percent of American households. (By contrast, the bottom 20 percent held about 3 percent of consumer debt—an increase from 1.9 percent—and accounted for a bare 4.5 percent of the growth.) If the rich are getting richer, it makes sense that they’re also running up more debt. They can reasonably expect to pay it.

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…some of the credit-card balances included in government statistics aren’t really debt at all. They’re temporary charges for convenience’s sake. Nowadays, credit cards are easier to use than cash—no fumbling for change while other shoppers wait impatiently behind you. Plus, companies offer rewards points and frequent-flier miles, and they give you a free float period if you pay your balance in full. So people who don’t need to borrow money use their credit cards as a convenience, running up charges over the course of a month and paying everything off when the bill comes due. Whatever they owe on the day that debt statistics are collected goes into the total figures on consumer credit. This “convenience use” grew from about 6 percent of total credit-card debt in 1992 to 11 percent in 2001, calculates Kathleen Johnson, a Fed economist. That growth was two and a half times the growth rate for credit-card borrowing overall.

Of course, rich people and families who pay their bills every month aren’t the only Americans with debts, and they certainly aren’t the ones whose sad stories make the news. But financial innovations have also made lower-cost credit more available to lower-income people. Even those much-criticized payday loans cost less than pawnshop loans or bounced-check fees. Credit cards are cheaper still.