Debt and Savings in Low and Moderate Income America

A report by the Employee Benefit Research Institute (EBRI) provides us with a view of household finances in the United States, focussing on households in the bottom 40 percent of all U.S. households with incomes under $35,600 annually.  These households are termed low- to moderate-income or LMI households.  This study used 2010 data gleaned from the Federal Reserve Board's latest Survey of Consumer Finances.

1.) LMI Household Debt Levels:

Most LMI households are not overly indebted; in general, households with debt payments that are greater than 40 percent of household income are considered to have unsustainable debt levels.  In the study, only 13 percent of LMI households had debt in excess of the comfort zone, the same level as was noted in 2007.  As well, only 11 percent of these households had debt that was more than 60 days overdue, slightly higher than the 8 percent level in 2007.  How is it possible that these modest income households have such low problem debt levels?  Largely because only 60 percent of LMI households had ANY consumer or mortgage debt.  Only 22 percent had mortgage debt secured by the equity in their homes, only 28 percent had outstanding credit card balances and only 38 percent had installment loans.  These numbers were at 22 percent, 33 percent and 35 percent in 2007.

2.) Household Savings Levels:

Most professionals advise that households have savings equivalent to at least three months of household income as a buffer for emergency situations.  In the case of LMI households, a typical household thought that it was prudent to have "precautionary savings" of $3000, however, a median household in the study had savings of only $2700 including retirement savings.  Only 37 percent of LMI households had savings of any kind at a bank or credit union.  The median amount in these accounts was $700 for low-income households and $1000 for moderate-income households.  Other than chequing accounts, very few households had savings in the form of certificates of deposit (9 percent), United States Savings Bonds (5 percent) and stocks outside of a retirement plan (5 percent).

For your information, here is a look at the dropping overall personal savings rate for Americans of all income levels showing how LMI households are saving far less than the average:

The personal savings rate is calculated as the ratio of personal savings to disposable personal income.  Since 1959, America's personal savings rate has ranged from a high of 14.6 percent in May 1975 to a low of 0.9 percent in October 2001.  At the beginning of the Great Recession, the personal savings rate rose from 2.6 percent in December 2007 to a peak of 6.5 percent in November and December 2008 and has since fallen to its current level of 3.6 percent.

Fortunately for America's LMI households, their debt loads are unlikely to cause them grief when the next economic slowdown hits.  Unfortunately, as the cost of most goods and services continue to rise and wage increases remain modest at best, it will be difficult for them to get ahead of the curve.

The Painful Impact of Ultra-Low Interest Rates

We are all quite aware that we are living in an ultra-low interest rate environment thanks, in large part, to the creative efforts of the world's central bankers.  This environment was created in response to the near collapse of the world's economy during the Great Recession and has been carried forward into the third year of the so-called "recovery" as a desperate means of stimulating a rather sick world economy back to health.  Thus far, the response of the world's economy to all of this cheap credit has been a resounding and reverberating "Meh".

Just so we can get a sense of how low interest rates really are compared to historic norms, here is a graph showing the benchmark interest rate for the United States since 1972:

Here is a graph showing the benchmark interest rate for the United Kingdom since 1972:

And, finally, here is a graph showing the benchmark interest rate for Canada since 1990:

While the central bankers of the so-called "developed nations" ponder why the world's economy seems so unresponsive to all of their machinations, there may be an explanation.  While this particular posting pertains to details about the issue in one nation, the same cause-effect relationship applies to all nations that are currently experiencing near-zero interest rates.

UHY Hacker Young, a United Kingdom-based accounting firm, has released a study showing that low interest rates are responsible, in part, for damaging the economy.  UHY estimates that the combination of high inflation (a United Kingdom Retail Price Index (inflation rate) of 3.5 percent) in combination with near-zero interest rates on savings and current accounts has resulted a decline in the value of the nation's savings.  UHY estimates that U.K. savers are losing nearly £18 billion per year as inflation erodes the value of their savings, even on higher interest savings accounts and longer-term locked-in investments.  While I realize that this data is specific to the United Kingdom, the same issue faces savers in Canada, the United States and other nations where interest rates are at or near historic lows.

The Bank of England reveals that over £115 billion is currently deposited in U.K. bank accounts that are yielding zero percent interest.  To put this number into perspective, these savings work out to just over 7.5 percent of the United Kingdom's GDP for 2011.  Since smaller investors experienced frightful capital losses during the stock market collapse of 2008 - 2009, many retirees, in particular, are cautious about seeking the higher returns that could be available by investing in equities.  Many would prefer to see their real net worth drop as inflation slowly eats away at their nest egg rather than to suffer from the sudden shock of a cliff-like decline in the stock market.  Despite historically low returns on savings, the United Kingdom household savings ratio was 7.7 percent in the fourth quarter of 2011 and 7.4 percent for all of 2011, up from 7.2 percent in 2010.

With no return on relatively risk-free savings, savers are much more likely to spend less.  Since much of the developed world's economies relies on consumer spending for continued growth, cutbacks in household spending on all of those wonderful toys and other non-essential items will be curtailed, ultimately having an impact on economic growth around the world.  This is a prime example of the law of unintended consequences; central bank actions may actually be hurting the economy rather than helping it.  

Thanks to QE, banks around the developed world are getting away with paying savers very little or nothing for their savings, generally offering rates that are well below the rate of inflation.  This means that your savings today are worth less in the future as inflation quickly eats up any investment income.  On the upside for the ruling class, extremely low interest rates mean that governments around the world can continue to spend far more than what they are bringing in because the interest owing on their debt is not punitive....at least, not yet.