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`Buy now, pay later' a very risky mantra

Customers line up for assistance at Turney's Ace Hardware in Chesterland, Ohio last month. The arrival of summer prevailed over consumers' worries about rising oil prices last month, sending shoppers into stores and giving retailers their best performance in more than a year. PHOTO: AP

Buy now, pay later: It's been the mantra of American consumers for decades.

The results are obvious in the ballooning balances on credit cards and mortgage loans, and in the mushrooming US trade deficit, which reflects the nation's nearly insatiable appetite for cheap, imported goods.

Low interest rates, especially since the end of the 2001 recession, have fed the debt beast at home, allowing American consumers to accumulate nearly US$11 trillion in debt as they buy more homes, more cars, more clothes, more dinners out.

At the same time, foreign investment in the US is helping to keep the dollar strong, which holds down prices on those imports Americans covet.

But what would happen if interest rates suddenly weren't so benign, or if foreign governments, corporations and individuals stopped investing so heavily in America?

Some analysts fear such actions could trigger doomsday scenarios in which the bills come due and Americans can't pay.

The consequences could be devastating for the US economy.

"The idea that a financial disaster could occur at any moment is too far-fetched for individuals to imagine during times of such heightened exuberance."

Study by Bear Stearns & Co Inc investment bank, New York

Several experts were asked to discuss these potential disasters and to offer a rebuttal for those who believe that while the country may be in debt, it's not in danger.

CREDIT CARD CRUNCH

The tool that has made it ever so easy for Americans to buy and buy is the credit card. And buy they have.

Outstanding balances on credit cards have risen to more than US$800 billion, or some US$7,200 per US household.

It's more than double the indebtedness of a decade ago -- and it doesn't include an additional US$1.3 trillion in debt for cars, appliances and personal loans.

What if interest rates suddenly shot up, say 3 percentage points or 4 percentage points, requiring burdened borrowers to greatly increase the amounts they have to pay each month on their debt?

"It would undermine the housing market, and could quickly result in credit problems that would affect the entire [US] financial system," says Mark Zandi, who is the chief economist at Economy.com, a forecasting firm in suburban Philadelphia.

Such an event isn't beyond the realm of possibility if global investors, for instance, shift their money out of the US or if a terror attack riles financial markets.

Some American borrowers already are in trouble, and more are likely to stumble as interest rates rise and the new bankruptcy law makes it harder for consumers to be relieved of their debt, said Howard Dvorkin, head of Consolidated Credit Counseling Services Inc. in Fort Lauderdale, Florida.

"You'll see creditors get more aggressive at collecting debt, the reason being that they can," Dvorkin says.

That will turn many borrowers into "the walking wounded," struggling to keep up with card payments and limited in what they can buy -- a massive drag on the US economy.

THE REBUTTAL: Skeptics don't see a big economic shock in the offing. Economy.com's Zandi says interest rates are most likely to go up at a measured pace, giving most consumers time to adjust to higher payments, and some may see their credit limits cut.

Still, much of the recent debt has been taken on by lower-income and lower-middle-income families, who borrowed aggressively to maintain their standard of living as wages stagnated.

"Going forward it will be harder for them to maintain their spending -- and their living standards," Zandi says.

MORTGAGE MANIA

Americans have taken on more than US$8.8 trillion in mortgages to buy homes, up an astounding 42 percent since the recession in 2001.

And rapidly rising prices in recent years have made many homeowners feel wealthy, so they've ramped up day-to-day spending.

But that run-up in prices -- what Federal Reserve Chairman Alan Greenspan has described as "froth" -- increasingly looks like a bubble.

"The bigger bubble is actually in the financing of homes," says economist Ed Yardeni of Oak Associates in Akron, Ohio.

Millions are buying homes with no down payments. Or they have adjustable-rate mortgages or interest-only mortgages or optional payment mortgages.

What brings such a great party to an end?

"Interest rates going up just 2 percent would do it," says Peter Morici, a business professor at the University of Maryland in College Park.

That, he says, would suppress prices, lower sales and put a squeeze on those who were marginally qualified to buy because their payments would suddenly go up.

"Some people will lose their homes," Morici says. "Many people will just be hurting."

A recent survey by a mortgage insurer, The PMI Group, Inc. of Walnut Creek, California, has found that the risk of home price declines has increased in 36 of the nation's 50 largest markets, with the danger greatest in Boston, New York's Nassau and Suffolk counties and the California cities of San Diego and San Jose.

THE REBUTTAL: Doug Duncan, chief economist for the Mortgage Bankers Association trade group in Washington, DC, acknowledges that there may be "tiny bubbles," particularly in areas such as Las Vegas and along both coasts, where speculators are rushing in to buy property and flip it quickly for a profit.

But most buyers, he says, see their homes as a place to live or to retire, with appreciation as "the frosting on the cake."

Duncan also believes Fed is sensitive to the potential impact higher rates could have on the housing market and will move cautiously.

MONEY MART

Why is everyone so worried about China?

The reason, explains the University of Maryland's Morici, is because "we're getting their T-shirts -- and the money to buy their T-shirts."

China's growing exports to the US are a major factor in the explosion of the nation's trade deficit, which could exceed US$700 billion this year.

At the same time, China is one of the largest foreign investors in US Treasury securities, with its holdings of US$244 billion, second only to Japan.

The Chinese buy American bonds -- and make other investments in the US -- because they need to recycle the dollars they earn from their exports.

China also has bought dollars to keep its own currency, the yuan, lower in value so its exports are more price competitive internationally.

Such investment in the US by foreign powers means, however, that "US financial vulnerability continues to grow," Lehman Brothers said in a research report.

Their concern is that American efforts to slow Chinese imports, perhaps by imposing quotas, could trigger retaliation from China.

If China stopped buying US securities, or even started dumping them, it would send the dollar into a tailspin.

That would not only make imports more expensive but could push interest rates up, ending the housing boom and maybe tipping the US economy into recession.

THE REBUTTAL: C. Fred Bergsten, a former US Treasury official who heads the Institute for International Economics in Washington, DC, notes that China said last month it would no longer peg the yuan strictly to the dollar but to a basket of currencies and allow its currency to rise gradually in value.

Even without that announcement, Bergsten thinks it "would be crazy" for China to alienate the US.

The reason: China needs America as a major export market to fuel its own economic growth and to create jobs.

DOOMSDAY PREDICTIONS

There have been any number of doomsday predictions that didn't come true. But a number have: The Great Depression was the result of a panic in the market; in the late 1990s technology stocks collapsed.

A recent study by analysts at the Bear Stearns & Co Inc investment bank in New York says most bubbles share the same characteristics: A sense of prosperity leads to speculation which leads to price pressures and a rise in interest rates which then can cause the bubble to burst.

The analysts believe at least eight of the 10 characteristics of a bubble environment currently exist in America.

But they are not surprised few see it: "The idea that a financial disaster could occur at any moment is too far-fetched for individuals to imagine during times of such heightened exuberance."
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