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Article by Mohan Babu


Managing debts during slowdown

Indians in the US are not immune to the debt trap. They are also susceptible to the vagaries of downturns, like their American compatriots, writes Mohan Babu

In recent times it has become extremely hard to get away from news and views on Enron. Of course, there is also a renewed interest in news on accounting, finance and debt in the corporate world. Experts have been analysing the Enron case from different angles, and have been looking at the impact on the broader aspects of our life, finance and society. The recent Enron crash has led many companies to take a hard look at the way in which they manage their debts and finances. The financial system is becoming more transparent with companies declaring more details. Investor jitters about corporate debts and finances are also starting to abate, although the significance of debts in corporate and personal worlds will continue to grow.

The recent spate of corporate bankruptcies and questions about corporate debts are also leading people to revisit their personal finances. Like companies, even individuals in America are treading on thin ice when it comes to debts and finances.

Historically, Americans have been pampered by access to easy credit and do not shy away from taking on new loans and mortgages. Many working-class Americans literally live from paycheque-to-paycheque, balancing their finances such that the next paycheque they draw goes right to service their loans, leaving very little disposable income. Right from the time they go to college, they start applying for credit cards and college loans. After graduating, they start acquiring other necessities of life like cars and other white goods. At some point, they decide to buy a house, which in turn locks-up a good part of the disposable income. Added to this is the contribution towards retirement planning (401 K, etc) that individuals make, leaving hardly any liquid disposable income in their hands. The philosophy of debt (and life in general), is to live for the present and not worry about the future.

While planning on new debts, loans and large purchases, most people try to forecast their future income and plan for the best-case/worst-case scenarios. However, the temptation to buy the latest model car, computer or DVD is generally too much, especially when sellers advertise “zero percent” loans. Also, it is hard to predict downturns and loss of jobs, especially when one is working in a “hot” sector like technology and things are really looking up. The swinging nineties brought in a sense of “irrational exuberance” and a false sense of security.

When the dirt hits the fan...

When the economy is doing well, as was the case in the nineties, everyone seemed to be happy. Creditors are happy to lend more to people and individuals are pleased to be consuming products without paying for them. No one worries about tomorrow, as long as they can make their “minimum” monthly payments. People continue to spend, oblivious to the fact that credit cards, mortgages, personal loans, car loans and second mortgages can easily add up to a substantial amount. In a growing economy, people have jobs, get raises and can afford to pay their loans and even take on more debts to pay old debts. It is when the economy goes south that all hell breaks loose. It can be especially painful when people lose their jobs and are unable to make payments. Almost similar to the situation being faced by companies which are unable to “service their debts” when their revenues are dropping during the current market slowdown.

The figures on personal debt in America are staggering. As per one estimate, the total household credit market debt is over 6,000 billion dollars, and the household debt as multiple of personal saving is over 45.5 percent. What this means is for every dollar an average person saves, he already has over 45 dollars in debt. Over 70 percent of Americans are living paycheque-to-paycheque. As per the administrative office of US Courts, in 2001 alone, over 1.4 million people declared bankruptcies!

Even Indians in the US are not immune to the debt trap. Credit cards are de rigueur. Most of us take car loans without batting an eyelid. Those with more stable jobs also buy houses instead of renting them. And like American compatriots, even we are susceptible to the vagaries of downturns.

Is borrowing bad?

It is not my intent to say that borrowing or debt is bad per se, actually some debt can be good. Most economists agree that the cycle of borrowing and repaying loans is what keeps the wheels of economy moving. Borrowing moderately can also help individuals maintain a higher standard of living, and consume goods that they otherwise couldn’t acquire immediately. This in turn helps manufacturers and sellers, leading to a ripple effect in the economy. It is only when the borrowing starts getting reckless, without any consideration for one’s ability to repay, that things get out of hand.

Until recently, Indians (in India) were quite averse to borrowing to pay for anything, firmly believing in the power of savings. For instance a person would save all his life before he considered buying a house, instead content to paying for the house from his retirement funds. All their lives, people were content to rent a house or apartment. Even buying white goods like TVs or scooters involved a lot of planning and deliberation. However, this trend is being reversed with the younger professionals having no qualms about borrowing money to pay for the snazzy new Maruti or a flat.

A slowing American economy, combined with crashing of large giants like Enron has lead to a greater scrutiny on debts and the ability to pay what is owed. After a period of hyper-growth, the economy is entering a phase of moderate, sustainable growth and even individuals are realising that they should not bite more than they can chew.




About the Author

  • A Bio and profile of the author, Mohan Babu, can be found at his homepage
  • Mohan has authored a book on Offshoring and Outsourcing (Publisher McGraw Hill, India), a link to which can be found here
  • Mohan has also authored an Online book on "Life in the US," available for free download.
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    For FAQ, Trivia and Information on Life in America, visit the Ask-A-Desi section

    ©Mohan Babu: All Rights Reserved 2005

    Mohan Babu is an international consultant trying to find the ‘sweet spot’ where IT meets business. E-mail: mohan He is also the author of a recent book on "Offshoring IT Services"

    All rights are reserved. Mohan Babu ("Author") hereby grants permission to use, copy and distribute this document for any NON-PROFIT purpose, provided that the article is used in its complete, UNMODIFIED form including both the above Copyright notice and this permission notice. Reproducing this article by any means, including (but not limited to) printing, copying existing prints, or publishing by electronic or other means, implies full agreement to the above non-profit-use clause. Exceptions to the above, such as including the article in a compendium to be sold for profit, are permitted only by EXPLICIT PRIOR WRITTEN CONSENT of Mohan Babu. 

    Disclaimer: This document represents the personal opinions of the Author, and does not necessarily represent the opinion of the Author's employer, nor anyone other than the Author. This Article was originally published in Express Computers


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