Can unpaid consumer debt speed recovery? Don't bank on it

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You might think making the case that unpaid consumer debt can speed the recovery is absurd, but The Wall Street Journalactually is doing just that in Monday's paper. The argument keys off Federal Reserve figures that put total household debt, including mortgage debt, at about $13.7 trillion, or 125 percent of annual after-tax income. The Journal's reasoning goes like this: As people deleverage, even if it's through bankruptcy and foreclosure, they'll move more quickly back to a more sustainable debt level of 100 percent. At that point, consumers would then be able to help with the recovery because they'd be in a position to spend again.

While I can understand the Journal's numbers, its story doesn't fully examine the actual impact on consumers (though it does say there's no guarantee spending will take off under this scenario).

The problem is that even though defaults on consumer borrowing would hasten the return to more normal debt levels, the impact that foreclosures and bankruptcies would have on a consumer's credit record certainly wouldn't bolster the ability to consume yet again. Credit terms are so much stricter now than they've been in the past 10 years that even consumers with good credit scores -- between 680 and 739 -- are reporting that they've been denied credit on numerous posts or in comments to AOL's WalletPop. I've asked banks about their underwriting terms numerous times, but their only response is that each application is handled on a case-by-case basis.

In the current economic climate, you can forget about getting a mortgage or possibly even a credit card with a rate of less than 29.9 percent, if you have a foreclosure or bankruptcy in your credit history. Many banks want to see a credit score of 740 or higher, whether you're seeking a credit card or a mortgage. For example, I have a friend who filed for bankruptcy at the beginning of 2003 and has had a perfect payment history since then with a credit score over 720, but he's still being denied credit. The reason banks give him is his previous bankruptcy.

As Mark Zandi, chief economist for Moody's Economy wrote in a recent column: "The resulting loss of household wealth is enormous and weighs heavily on consumers' willingness and ability to spend. Since the peak in housing wealth, homeowners have lost more than $5 trillion in home equity, and close to 15 million homeowners -- more than a fourth of all those with first mortgages -- are estimated to be under water; their homes are worth less than they owe. With nest eggs so cracked, households are in no mood to spend more."

While the cleansing of bad debt off the banks' books may help speed them back to health, I doubt that the same thing would happen with consumers. And the Journal points out that rising tax burdens as the government pays down the soaring national debt won't help consumer spending. We're clearly digging the economy deeper into a hole that consumer spending won't be able to fix.

That's a serious problem since such spending makes up two-thirds of the U.S. economy and about one-fifth of the global economy. Without consumers taking the lead, who will?

Lita Epstein has written 25 books including The Complete Idiot's Guide to Improving Your Credit Score.

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