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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.
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