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April 28, 2014

Mortgaging Tomorrow to Pay for Today

The WaPo begins a long article about how the middle class can barely make ends meet with the sad tale of a couple who make almost twice the median income, yet had no money put away to replace a car with over 200K miles on it. Replacing it with a used car (we're told) caused them not to be able to pay their electric bills:

The Johnsons both work, earning $90,000 between them, not a princely sum but one that places the couple squarely in the middle of household incomes for the Washington region. But for the Johnsons and many other American families, being middle class means living paycheck to paycheck.

The couple’s retirement savings are meager. The college fund? Nonexistent.

We're supposed to believe that this couple are living paycheck to paycheck because they don't make enough money. But as their tale unfolds, a disturbing pattern emerges: they repeatedly spend money on "wants" and defer spending on "needs":

One factor behind the financial squeeze is that the middle class’s expectations — a house, music and dance lessons for the kids, the latest in home entertainment — have stayed the same or increased even as costs have soared.

A while back, we wrote about how artificially cheap credit was crowding out household saving. Essentially, American families are deliberately choosing not to save, relying on loans to cover the growing gap between what they spend and what they earn. And contra the WaPo's misleading assertions, wages aren't really stagnant and the basic cost of living has actually gone down over time:

Many articles on household savings cite unemployment or stagnant wages as possible causes. But unemployment can't possibly account for three-fourths of households not putting money away against hard times. And the supposed stagnation of wages doesn't stand up well to critical scrutiny. As this article points out, the average wage over time hasn't risen for several reasons:

1. Benefits like health insurance, pension funds, and paid leave have grown to 31% of total compensation, and these benefits aren't included in the calculation.

2. Even when wages are adjusted for inflation, the same salary has far more buying power today than it did 40 years ago.

3. The entrance of women and immigrants into the job market caused rapid growth of low skill/low wage jobs at the bottom of the pay scale. These job pull the average wage down.

The reduction in the cost of living over time is stunning:

According to the Bureau of Economic Analysis, spending by households on many of modern life's "basics"—food at home, automobiles, clothing and footwear, household furnishings and equipment, and housing and utilities—fell from 53% of disposable income in 1950 to 44% in 1970 to 32% today.

More on the reduction in basic living expenses over time. A little farther in the article, another "struggling" couple are spending money they don't have on luxuries and neglecting the (now relatively cheaper in constant dollars) basics:

While they struggle to meet basic expenses, the Johnsons’ home is filled with the electronics that have become a standard part of middle-class life in the 21st century. For $90 a month, a satellite dish provides basic television service for their three flat-screen sets and for the WiFi connections Scott needs when he works from home. They have one laptop and three iPads, and each girl has a computer in her bedroom. The bill for four cellphones runs about $300 a month.

Like many American homeowners over the past several years, they got a break on the mortgage by refinancing to a lower interest rate, stretching the remaining payments from 14 years to 30. It cut the monthly payment almost in half, down to around $700 a month.

The money was immediately sucked up. Scott expects his salary at the hospital to be frozen because of Medicare cuts. And the couple keeps postponing maintenance on the family’s 30-year-old home.

The air conditioner stopped working four years ago. The dishwasher is busted, too. The roof is missing a few shingles and leaks in a heavy storm. Last month, Scott installed a hand-me-down cooktop given them by a friend who remodeled her kitchen.

The problem here isn't lack of income. It's poor money-handling skills and a screwed up sense of what's most important.

There has been growing evidence in recent years that increasing numbers of children are starting school without being fully toilet trained.

Experts say it is not just pupils from deprived backgrounds who are having problems but those who have working parents too busy to address the issue.

Meanwhile, in response to complaints that it's "too hard" to make student loan payments, our government has stepped in to make things easier.... with predictable results:

A new report by the Federal Reserve Bank of New York finds that as of the fourth quarter of 2012 only about 40% of student borrowers were paying down their loans. About 17% were delinquent, defined as 90 days past their due payment. Hard to believe, but this "measured delinquency rate" is higher than any other consumer debt product, even credit-card debt.

Yet it is only half of the "effective" delinquency rate. A whopping 14% of borrowers who were not officially delinquent had the same balance as the previous quarter and 30% saw their balances increase.

That's because borrowers who can't afford to pay down their loans can ask the government for a deferment or forbearance, which freezes their payments while interest continues to accrue. During a deferment, Uncle Sam pays the interest on subsidized loans. To qualify for either option, borrowers merely need to claim an economic hardship or return to school. Borrowers can postpone payments indefinitely by enrolling in college half-time—during which time they can take out even more loans. Borrowers can use the loans to pay for incidental living expenses.

Heavily indebted borrowers can also enroll in an income-based repayment plan, which caps monthly payments at 10% of their discretionary income—about $150 per month for someone earning $30,000 annually. The government then forgives the entire outstanding loan after 10 years of making these minimum payments while working for a nonprofit or the government. You have to wait 20 years if you work in the profit-making economy.

But as the New York Fed report notes, borrowers who participate in income-based repayment plans may "make only small payments, which are often insufficient to cover the accumulated interest." Thus their loan balances grow.

Student loan debt nearly tripled to $966 billion in 2012 from $364 billion in 2004, but not merely because more students are going to school and taking out bigger loans. The Fed report's major finding is that government programs intended to prevent defaults are actually causing many borrowers to rack up more debt. Yet these borrowers aren't included in the government's official default or delinquency rates.

Eliminating painful consequences doesn't help people do a better job of managing risk. It entices them into ignoring risk.

Income inequality isn't the defining problem of our age. That honor belongs to moral hazard.

Posted by Cassandra at April 28, 2014 06:49 AM

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On a similar note: http://online.wsj.com/news/articles/SB10001424052702304418404579467141423574578?mg=reno64-wsj

Demand-side economic policies penalize savers and reward debtors, while failing to do anything to "stimulate" the economy. It's all just using tomorrow's capital to solve today's problems, whether it's the U.S. Govt. or ordinary families doing it.

When I read about people with many hundreds of dollars a month in cellphone/internet charges and three televisions--but who can't save for college or fix the roof--I sense my parents spinning in their graves. And you know these are exactly the people who "can't save" for medical emergencies, and so consistently vote for free healthcare schemes.

Posted by: Texan99 at April 28, 2014 10:24 AM

Many years ago, I read Jane Bryant Quinn advising that when you got a raise, keep living like you didn't and bank the extra money. Good advice but what really stuck in my head was her tag line: Don't say you can't do it; lots of people live on less.

As for cellphones, I keep seeing ads for some company informing me happily that I can get four accounts for "only" $160 a month. Every time I see that I fall into a swoon. Hearing that the Johnsons are spending $300 a month for four cellphones caused me to pass out cold.

Either I'm getting old or a lot of people are getting crazy. Or perhaps both.

Posted by: Elise at April 28, 2014 10:39 AM

For many years my father put every raise into his retirement savings. He seemed to lack any notion that our standard of living needed to improve over time. It was a lot nicer than what he'd grown up with: our food, shelter, clothing, and medical care were all secure if not lavish.

The idea that he would let a home repair go undone because the communications/entertainment budget was sucking up all the cash? Absolutely inconceivable. Somehow he managed to budget for necessities without borrowing, and put three daughters through college to boot.

Posted by: Texan99 at April 28, 2014 11:10 AM

The entire point of the unopposed Liberal/Left political cabal as it operates now is the destruction of a self-sufficient middle class. That class was once the center of Liberal affections, especially lower middle class blue collar unionized workers championed by such as Scoop Jackson and H Humphrey. The very success of that class made its political loyalties more than suspect when they attached themselves to Reagan. A new electorate would be necessary.

And so, groundswells of immigrants, their assimilation made moot by the elevation of their native cultures to greater than the host; and too, the impoverishment of the middle class, and their children and children’s children.

Mene, Mene, Tekel, Upharsin. No autocracy is possible with an independent middle class.

Posted by: George Pal at April 28, 2014 11:24 AM

The Johnsons also own two cats.
Just sayin'.

Posted by: Rex the Wonder Dog at April 28, 2014 12:03 PM

$300 cell phone bill!?!!!!!!!!
Look, I have, arguably, the most stereotypically *dangerous* teen out there -- 15 yr old girl w/a cell phone -- and I'll be damned if I'm going to pay through the nose like that just so she can text (cause they have no idea that the *phone* part of the cell phone means they can actually talk on the damn thing, too) her friends a hundred times a day.
We've talked about skewed priorities many times here at VC. Examples like these though, seem to be becoming the norm lately. When are these people going to finally become the adults they claim to be?

Posted by: DL Sly at April 28, 2014 12:40 PM

The Johnsons also own two cats.

With their own Smartphones, no less :p

Posted by: SlogansRUs at April 28, 2014 01:07 PM

When we were first married (and either below the poverty level or barely above it), credit was extremely expensive.

But we always had savings. Always. And we did a lot of share-secured loans (basically, you put your own savings up as collateral to get a vastly reduced interest rate on a new loan, then put the new loan on automatic payment to build your credit rating).

The older I get, the more I think the expectation that everything should be easy and nothing should require advance planning or effort to be the most dangerous threat to civilization around.

Posted by: Cassandra at April 28, 2014 01:25 PM

I can reduce that down even further...and neither am I a math wizard nor did I stay at a Holiday Inn Express last night!

The habitual need for instant gratification is the most dangerous threat to civilization.

That why we were taught to "save for a rainy day" when we were kids. Or, later in life, learned to not follow the impulse buy reaction to something shiny, but to wait and see if we really wanted or needed it later. These lessons were not just about money, though. They also taught us to not jump at the first "good" thing to come by; to wait for the right person; to perservere in dull college classes to get a degree that will get you the job/career you want when you get done; to see the value in fixing a car that has a few miles on it, but you own the title and it's gotten you through literally hell and high water. Sadly, a couple of generations of kids were not taught these important life lessons. Therefore, they will never know the pure joy that comes from realizing the fruits of your patience - celebrating a life well-lived with a single partner; retiring in comfort at the end of a long and successful career; watching that *old* car ease another generation of drivers onto the road.

They will have long placed the needs of Now over the requirements necessary for the Future, and when, having done so, they are raising their own "next generation", what lessons will they teach? One of personal gratification and expediency? Or will the pendulum, with the full weight of a stagnant society hanging precariously onto one side, finally start to swing back? And if it does, will there be anyone left who remembers the "old ways"?

Posted by: DL Sly at April 28, 2014 02:19 PM

I will say, while I don't have children, my wife and I do well enough on literally less than half of what that couple is quoted as having.

Posted by: MikeD at April 28, 2014 04:04 PM

These lessons were not just about money, though. They also taught us to not jump at the first "good" thing to come by; to wait for the right person; to perservere in dull college classes to get a degree that will get you the job/career you want when you get done; to see the value in fixing a car that has a few miles on it, but you own the title and it's gotten you through literally hell and high water.

Amen, sistah. Now GET OFF MY LAWN! :)

Posted by: Cassandra at April 28, 2014 06:16 PM


Hey, hey, hey, I'm walkin' here!

Posted by: DL Sly at April 28, 2014 07:15 PM

One problem is that saving - putting money in a bank - is not very rewarding. You could get almost as much return by putting it in sealed cans and burying it in the back yard.

On the other hand, it's better than nothing, I suppose.

Another problem seems to be that among the many failures in our educational system is the lack of financial education. Even high-school graduates should know the basics of investing - if nothing else, the difference between a regular IRA and a Roth IRA.

A more recent problem is this oppressing student loan thing. People come out of college owing thousands - in 2013, the average debt was about $29k. I shudder to think what it is for medical school.

It's almost as if the System is being gamed against getting up into the middle class.

But the beauty is that that lets the government sing the "income inequality" song, which we're supposed to interpret as "rich people are bad, because they must have done something bad to get there".

Posted by: ZZMike at April 28, 2014 08:24 PM

It's occurred to me that the peculiar tone of my family of origin left me with the unconscious assumption that the greatest virtue and skill concerned the ability to do without. My parents were frugal, stoic sorts. They weren't great innovators or risk-takers, or people likely to thrill anyone's heart with great works of art or passion, or to yield to generous impulses. I probably grew up with an excessively negative view of virtue, in which the greatest accomplishment was not to give much trouble to others by demanding more than was reasonable. I rarely give much though to the more positive duty of creating a surplus so that it can be generously given away.

Nevertheless, I think if the average citizen isn't being incredibly productive, creative, and generous, the least he can do is learn the negative virtue of moderating his demands so that they don't burden everyone around him. I have no patience for people who run up debt and then dishonor it, while telling themselves they had no choice but to consume everything in the world it happened to occur to them to desire.

Posted by: Texan99 at April 29, 2014 10:13 AM

I'm a firm believer in the concept that money is made to be spent. Period.
I do OK as far as pay is concerned. Even last year when the Sequester mauled my paycheck I was still able to buy THIS which I absolutely love. Yes, that's me.
I'm kinda with the Johnson's as far as blowing money goes. Where we part ways is that I don't blame the government, society or anyone else if I can't make ends meet. I like to pay cash as much as possible and I don't even own a credit card. I have a government card in my name, but it's the governments, not mine.
I do everything with cash or debit cards and if I don't have the money for something then it'll have to wait.
I have good savings and TSP money, but I'm not married and have no kids, so my goal is to have just enough money left when I die to buy a casket, a plot of land and pay someone to plant me.
My opinion could be modified if future circumstances warrant. But for now money is made to be spent.

Posted by: Joatmoaf at April 29, 2014 06:42 PM

Slouching towards Gomorrah chapter 200.

Posted by: CAPT Mongo at April 29, 2014 10:47 PM