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posted on 15 September 2016

U.S. Household Finances: It Only Looks Like The Good Life

by Danielle DiMartino Booth, Money Strong

Money Strong Article of the Week

Of all the recognized generational cohorts dating from the American Revolution, it is the 13th or the Generation X cohort which demographers find hardest to define.

stork.baby.380x220

Did the stork deliver the first Gen X-ers as early as 1960 or as late as 1965? Was the end date for their births 1976 or 1984? And what of their collective character? At one time they were considered to be disdainful apathetic slackers, but since have become known as confident, hardworking and extremely entrepreneurial.

What is not in question is their unforgettable movie characters whose reasons for being were to make us laugh, not cry. Think Sixteen Candles' hysterical foreign exchange student, Long Duck Dong and the impossible, too cute to rebuke truant, Ferris Bueller. And who didn't harbor a soft spot for Pretty in Pink's Ducky or Chet in Weird Science? It was the 80s, and even outcasts could be transformed into loveable friends on the big screen. You just can't deny the affection we all felt for every last recipient of Saturday detention as The Breakfast Club credits rolled along to our anthem, "Don't You Forget About Me?"

But then there was Less than Zero, which more than made up for the rest of the light-hearted lot. The 1987 hit stands as the Eighties' testament to Film Noir replete with shoulder-pad wardrobed femme fatales, darkly doomed heroes and even nastier anti-heroes. Can anyone argue James Spader as a debt-collecting drug dealer was his least likeable character? Of course, the movie made an icon out of Robert Downey, Jr., whose stoned character gave new meaning to, 'Don't Leave Home Without It,' when he tried to swipe his American Express card to gain entry to the family mansion's (open) sliding glass door.

The film's byline, "It Only Looks Like the Good Life," summed up the Yuppie era to a tee, a time when U.S. households woke to the idea of aspiration, as in aspirational lifestyles. Longing to break free from their parents' frugal ways, many Baby Boomers embraced the relatively novel world of easily accessible debt with relentless relish.

Of course, it was a different place from which to take a leap of fiscal faith. Both the saving rate and 5-year jumbo CD rate were 7.9 percent when Less than Zero was released in November 1987. Inflation, meanwhile, had finally been tamed and was running at about half the rate people were setting aside in rainy day funds.

You might be thinking, hmmm, wasn't something else going on about then? Well, yes, of course. It would be daft to ignore the other thing that had just taken place in the weeks before the afore mentioned less than joyful downer of a movie was released, known to market historians simply as Black Monday.

Unlike the movie though, the markets didn't end in a funeral scene. In fact, October, November and December 1987 proved to be a splendid time to jump into the markets, which investors were in fact encouraged to do by the new sheriff in town, a soft spoken Federal Reserve Chairman the world would come to revere as The Maestro.

In early May, 2000, the Wall Street Journal took the occasion of the Nasdaq finally capitulating to gravity to publish, "How Alan Greenspan Finally Came to Terms with the Market."

"He became Fed chairman two months before the 1987 crash, and his first major task was to pick up the pieces. He sought a way to predict at the beginning of each day how U.S. stocks would open, a precursor to the futures markets that have since evolved to perform that task. During volatile periods in the late 1980s, a Fed staffer would arrive at the office at 5 a.m., call Europe to find out trading activity and have that day's forecast on the chairman's desk by 7:30."

Bear in mind, the Fed's mandate was then and remains to maximize employment while minimizing inflation. Becoming an expert on stock market trading patterns isn't buried anywhere in the fine print of its 1913 charter.

Did it take investors long to catch on to Greenspan's new and improved mandate? Not hardly. Interest rate moves were not announced back then. Still, investors could plainly see the dramatic decline in yields as the Fed pushed the fed funds rate down by a half a percentage point, to just below seven percent the Tuesday after that fateful Monday in 1987.

As Reuters columnist James Saft wrote on the 25th anniversary of the crash,

"The response, like a kid given its first sugary soda, was electric, with a strong rally winning back a small portion of the earlier losses. The Fed kept at it in the coming months, operating quite publicly, and often giving trading desks advance notice, and repeatedly taking overnight interest rates lower."

With that, the rules of the game changed. Traders began gaming the Fed and profiting from the increased confidence that stock prices were front and center for policymakers.

Of course, households had nothing to complain about as many rode this stock market wave to paper riches. Pray tell, how did they respond to this wealth accumulation? For millions of Yuppies, the answer came down to shopping till they dropped.

Households had piled on upwards of $160 billion in credit card debt as the New Year rang in on 1988. But that was nothing compared to what was to come with the advent of securitization one year later. Care of deregulation, another gift Greenspan bestowed upon the financial markets, lenders began to sell off slices of credit card-backed debt to an investor class that grew hungrier for cash equivalent income as interest rates embarked upon the decline of a lifetime.

The more yields slumped, the stronger the demand for all manner of asset-backed debt. Of course, we all know how this story ends. What began with car loans and credit card balances eventually led to bonds backed by home mortgages and ultimately the subprime crisis.

Households' response would surely have been a curiosity to those who lived through the Great Depression. But that culture of prudence had long since been written into the history books as a curiosity of its own. What replaced the frugality was in a word, perverse. The more households were worth, the less actual money they had in the bank.

Before all was said and done, credit card debt was pushing $1 trillion and the saving rate had plumbed new lows, as in into negative territory, as home equity was cashed out hand over fist. Americans were spending more than they were taking in at the greatest clip since the Great Depression.

Of course, all of this bad behavior came to a crashing halt with the advent of the other event that merited a 'Great' label - the Great Recession of 2009. After peaking north of $1 trillion in December 2008, credit card debt eventually troughed just below $800 billion in April 2012. Until very recently, the growth rate of credit card debt was unremarkable; the total outstanding continuously bumped up against a $900 billion ceiling.

Last year, though, the cycle finally turned and for the better if you ask most economists. According to Standard & Poor's, at $969 billion, revolving credit is at the highest level since April 2009, before the bottom completely fell out of the economy. This figure, which is once again flirting with a 'trillion' handle, is up $54 billion over the last 12 months. This 'improves' upon the $12 billion, $34 billion and $46 billion gains over the same 12-month periods ending in 2013, 2014 and 2015 respectively. We are told that increased usage of credit is a sign of confidence, a sure signal that households view the job market's prospects as healthy looking ahead.

Indeed, consumers' median household income growth expectations rose to 2.9 percent in August from 2.8 percent in July and 2.75 percent in June according to a report the New York Fed released September 13th. Why then do their expectations for missing a debt payment remain near the highest level in two years? Moreover, why did consumers' spending growth expectations decline to 3.3 percent in August from 3.8 percent in July and 3.6 percent in June?

According to the NY Fed, the downshift in expectations reflects consumers over the age of 40 and lower income households. That's intuitive enough if you consider these two cohorts get hit hardest by healthcare and rent inflation, both of which are running at twice the pace of income growth. Perhaps a separate part of the story is rising minimum wages in many parts of the country. Do rising prices for necessities thus connect the dots between rising income and falling spending expectations?

It's hard to say for sure without conducting a comprehensive survey of every working American. On a more philosophical level, one must stop and ask whether it's a good thing that car, student and soon-to-be credit card borrowing all surpass $1 trillion?

Surely living within one's means was once the American way for good reason before low interest rates and lax lending standards encouraged that standard to be stood on its head. Presumably the debate will rage on until the stock market pulls back and/or interest rates rise, or even worse, both.

High income earners dominate consumer spending but can also bring the economy quickly to its knees. A falling stock market could thus trigger a recession given consumption is the only pillar of strength remaining in the current recovery. As for rising interest rates, households, corporations and especially Uncle Sam can hardly afford that prospect to become a reality, especially in the uncontrolled manner they've risen since rates bottomed in July with nary a Fed rate hike to catalyze the move.

Falling stock prices and rising interest rates occurring concurrently is thus a central banker's worst nightmare. Such an impossible scenario unfolding would be a dark ending to a 30-year feature film all about a party that never seems to end, until it does erasing so many facades and leaving the simple reality that it only looked like the good life. Nothing in life is free. And sometimes the payback can be less than zero.

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