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[tvoivozd AT roanoke.infi.net]

The article below from NYTimes.com 
has been sent to you by tvoivozd AT roanoke.infi.net.


There's some question which shock will come first, or whether several will 
come at once, like energy, water supply, the accumulating environmental 
disaster in the form of poisons now affecting twenty five percent of the U.S. 
population---but a Federal and personal debt implosion is likely to occur 
ahead of the others.

tvoivozd AT roanoke.infi.net


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The Next Shock: Not Oil, but Debt

September 5, 2004
 By DANIEL GROSS 



 

WITH oil prices hovering above $40 a barrel, experts have
calmed frayed nerves by noting that today's services-driven
American economy is much less addicted to the black stuff
than yesterday's industrial economy. From 1973 to 2003,
after all, the amount of oil and gas needed to create a
dollar of gross domestic product fell by half. Structural
changes in the economy have let the nation absorb the
recent shock of rising crude. 

That's the good news. The bad news is that other recent
structural changes in the economy - the federal
government's shift from surpluses to huge deficits, the
national predilection for consumption over saving and
housing prices that climb faster than incomes - have
increased the country's reliance on another kind of fuel:
credit. 

As a result, the American economic ship, which has
weathered the recent run-up in crude oil prices, may be
more vulnerable to sudden surges in the price of money. If
the rate on 30-year fixed mortgages were to rise from 5.4
percent today to 7.5 percent next February, homeowners
could get walloped. 

"Rather go to bed supperless than rise in debt," Benjamin
Franklin wrote in Poor Richard's Almanac. Well, in recent
years, American consumers, businesses and governments have
been hitting the sack with their stomachs bloated and their
charge cards maxed out. From 1988 to 2000, the ratio of
nonfinancial debt to gross domestic product held steady at
about 1.8 to 1. But recently, consumer, business and
government credit has bulged like the belly of a contestant
at a hot-dog eating contest at Coney Island. 

>From the beginning of 2001 to the end of 2003, the economy
added $1.317 trillion in gross domestic product and $4.2
trillion in debt. 

That means that each new dollar of economic output was
accompanied by $3.19 in new debt. So now, for the first
time, the debt-to-G.D.P. ratio stands at more than two to
one. 

Throw in financial credit - the debt that investment banks
and others use to finance trading activities and the like -
and total debt has more than doubled since 1994. The mere
existence of huge debt needn't be a source of panic. You
and I may view debt as an economic input - we borrow so we
can spend and invest, and hence, as politicians like to
say, "grow the economy." Academic economists view it more
as a byproduct. Debt is created when people, governments
and companies spend money, trade and produce. 

VIEWED that way, the sharp rise in credit in recent years
isn't surprising or even, in and of itself, alarming. "When
interest rates are low, you'd expect people to pile on more
debt per G.D.P. because it's cheap,'' said J. Bradford
DeLong, an economist at the University of California at
Berkeley. 

What's more, as anyone who has ever used a mortgage
calculator knows, lower debt-service costs can make higher
levels of debt seem eminently manageable. Here is a
gigantic example: 

In 1997, when the total national debt stood at $5.4
trillion, Washington paid $356 billion in interest. In
2003, when the national debt grew to $6.8 trillion, Uncle
Sam's interest bill fell to $318 billion. The environment
of ultralow interest rates engineered by Alan Greenspan,
the Federal Reserve chairman, thus sharply muted the impact
of Washington's fiscal recklessness. 

But the economy's apparent reliance on credit to fuel
everything from home buying to the military budget is
troublesome. If incomes and revenues fail to rise, stressed
consumers may have a tough time keeping up with payments.
"It's been much more a matter of households borrowing than
businesses," said Benjamin M. Friedman, a Harvard
economist. "You have to hope that people are going to be
able to service the obligations they've taken on." 

An economy hooked on debt also is vulnerable to the
seemingly inevitable rise in interest rates. And in a
period when prudence would seem to dictate locking in
rates, Americans have rushed to assume greater
interest-rate risk. Borrowers - especially homebuyers -
haven't reacted to recent increases by borrowing less. 

In the first quarter of 2004, debt rose at an annual clip
of 8.6 percent, more than double the growth rate of the
economy. No, we've kept the interest bill down by swapping
fixed-rate for adjustable-rate financing. The Mortgage
Bankers Association reported that adjustable-rate mortgages
constituted 35 percent of new mortgages in the second
quarter this year, up from 27 percent in the fourth quarter
of 2003. 

Consumers, whose maxed-out credit cards generally bear
floating interest rates, and the federal government, which
skews its borrowing to short-term instruments, have
essentially done the same thing. So if interest rates rise,
we'll all have to spend more dollars on debt service,
leaving fewer dollars for more productive uses - like
buying 90-inch flat-screen TV's. If money becomes more
expensive, we may have to downshift our spending and
consumption, like drivers trading in expensive Hummers for
gas-sipping imports. And that may shrink the economy. 

HIGHER collective leverage, in turn, means that we're more
susceptible to external shocks. "The bigger the debt, the
smaller the margin for error,'' said Austan D. Goolsbee, a
University of Chicago economist. Companies with no debt can
weather several lean quarters; companies with piles of debt
often find that a single bad quarter spells disaster. 

The same holds for consumers. All kinds of wild cards that
are scary even in placid times - another spike in gas
prices, a rupture of the housing bubble, fresh job losses,
a period of sustained inflation - become nightmares during
times of greater leverage. So as we go to bed with our
suppers and our home-equity lines of credit, Professor
Goolsbee says: "I think we should be a little nervous." 

http://www.nytimes.com/2004/09/05/business/yourmoney/05view.html?ex=1095394529&ei=1&en=67564b72e15597d8


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