Rethinking the Credit Culture

The appeal of credit as an important engine of consumer spending is now coming into question. Since the summer, conditions in credit markets have been making headlines as the subprime mortgage crisis has brought the global lending machine and financial markets worldwide to uncertain waters.

Want vs. Need

In his new book, The American Mania author Peter Whybrow makes the case that consumers’ astonishing appetite and excessive consumption lies in our acquisitive pleasure seeking behaviors. Juliet Schor, (a Harvard professor of economics) in her book The Overspent American agrees.

But in looking beyond what we want and we don’t need, these and other authors acknowledge that many consumers have amassed debit balances due to other reasons.

In The Two-Income Trap authors Elizabeth Warren (a Harvard law school professor) and Amelia Warren Tyagi noted that many Americans are self employed and many others work for small employers. These workers are subject to periodic disruptions in earnings. Sometimes Dad’s paycheck due on Friday doesn’t arrive until Tuesday. During the five days until the check is deposited groceries were needed, medical co-payments had to be met and such expenses were covered with short-term debt from credit card issuers that doesn’t get paid off when the paycheck finally arrives.

Whether the debit balances now on clients’ financial statements came from excessive consumption or from circumstances outside of their control, they place an unprecedented burden on consumers.

The Double Whammy

One current trend in wealth management encourages clients to borrow at low interest rates and apply the cash to market investments. The NASD frowns on such practices when real estate is leveraged. This is especially disapproved when the home is leveraged for outside investment purposes.

Some slick investment advisors collaborate with mortgage brokers to execute this kind of scheme thinking that a regulatory review of the transaction would see them as two separate and independent transactions. They hope that examiners from one agency will see only the mortgage broker handling the financing while the regulator from another agency sees only the stock broker investing funds. In fact, they are planning to side-step the rules; and they proceed with unclean hands.

The potential problems in such transactions are being visited upon the clients now. The current decline in property values (once thought laughable) is now being coupled with falling values in stocks and bonds. Clients are unable to sell the highly-leveraged properties without infusing more capital to satisfy the liens. Declining values in market securities makes it difficult for clients to raise cash without booking losses in those assets.

Gasoline was poured on this fire when two more leverage factors were added. Some clients, lured by low initial payments, leveraged their property through adjustable rate mortgages – now ready to adjust. And to compound the issue, some clients purchased securities on margin and are now experiencing margin calls.

Basic Rules

The allure of the credit culture – whether involving consumer goods on plastic revolving debt, paychecks arriving late, or more sophisticated leveraging strategies involving real estate and marketable securities – can result in the erosion of good sound principles of personal finance. There is value in having equity and avoiding debt.

Recently a New York Times business writer commented that having a low interest mortgage is “good as gold”. Let’s all remember that a debt, no matter how fashionable or attractive, is still a liability. The old adage that the “the one without debt is the one without worries” is worthy of remembering.

Cocktail party babble ridiculing debt elimination in favor of the easy access to credit ignores a priceless truth; there is a world of difference between having money and having purchasing power. If the purchasing power comes through the extension of credit, what happens when the credit lines are cut? Others can take away your credit with ease. Taking away your money is another matter.

The Wrong Kind of Portfolio

An increasing number of Americans have now amassed a portfolio of personal liabilities that surpass their gross annual income. The Woodstock Institute of Applied Research recently reported that household debt rose from 71% of disposable household income to 126% between 1979 and 2005. That’s an average of American consumers in figures last compiled nearly three years ago. Some consumers owe even more.

Treating those liabilities as a portfolio requiring management calls for clear thinking, mature reasoning and decisive action. A professionally administered program directed to the liquidation of 100% of creditor obligations can reliably eliminate those debts in less than ten years including the mortgages. This worthy undertaking should not be attempted as a do-it-yourself pastime. Nor should it be confused with pyramid sales vending over-priced software.

Real financial liability portfolio management requires an experienced and vetted service provider. Included in the phases of this expert service are financial restructuring, the application of technology and the delivery of plan-fulfillment and administration. If the right service provider is selected the outcome will be predictable to a mathematical certainty.

The Tumble-Down Effect

When Albert Einstein is famously quoted as saying: The most powerful force in the universe is compound interest”.

Just as we readily accept the miracle of the compounding effect of interest upon money, the same wonder occurs when funds are regularly applied to a disciplined program of directed to the liquidation of liabilities.

Some are incredulous on hearing that the portfolio of liabilities that accumulated over a life-time can be eliminated usually in eight-to-ten years. Applying an inverse of the compound interest effect, the application of money to debt creates a “Tumble-Down” effect. Once a debt is eliminated, the capital previously dedicated to that item is redirected by the technology in the most efficient manner. The step is repeated each month as the effect of payments on balances is recalculated and new efficiencies are computed.

For the client such a service should be entirely passive. In a short time clients are entirely liability free, owning their home outright, and with no more outlay than they were committing to their creditors prior to enrollment and, as there are no negotiations with creditors, the client’s credit rating is improved.

Still relatively new, this service of financial liability portfolio management is one that thousands enjoy now and many more are finding make good common sense to embrace.

If you are not discussing your clients’ creditor obligations with them and recommending liability portfolio management when needed, shouldn’t you be?

Download this article in PDF format: Rethinking the Credit Culture

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About Andy Schweitzer

Connecting the Dots: Insightful financial services commentary and market observations from around the globe.
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