Middle-class debt could slow recovery

March 28, 1994|By New York Times News Service

WASHINGTON -- New figures from the Federal Reserve show a weak spot in the economic recovery: the heavy burden of debt being carried by the working middle class.

While the household finances of the rich and elderly have returned to normal levels, middle-class families remain stuck with unusually high debt payments as a proportion of their income, according to the Fed figures. Families that are not rich or old are paying nearly a quarter of their income to creditors, up substantially from levels in previous economic recoveries.

That high debt, resulting from stagnating wages while low interest rates have encouraged families to borrow, means consumers are living close to the financial edge and ready to cut spending at any sign of economic trouble.

But it is consumer spending that is fueling the recovery, and economists worry that overstretched middle-class families could put a powerful brake on the economy.

Further, more and more people's savings are in Individual Retirement Accounts and 401(k) plans, which save money on taxes now but impose stiff penalties for early withdrawal. This reduces families' financial flexibility -- they are unlikely to dip into savings to continue spending when to do so is difficult and expensive.

"What seems to be one of the best of times financially for our country as a whole stands, in contrast, to what is arguably one of the riskiest times that large parts of the house hold sector have faced in many years," said Lawrence B. Lindsey, an influential member of the Federal Reserve Board who presented and analyzed the new figures in a speech in Baltimore earlier this month.

"I believe that the household sector poses one of the most serious risks to the continuation of this recovery."

Interest payments and repayments of principal continue to claim an unusually high proportion of household incomes for families that earn less than $200,000 a year and have no one old enough to qualify for Social Security or Medicare.

These payments by middle-class families consumed 22.9 percent of these households' after-tax income last year, down from a peak of 25.9 percent in 1990, but still far above the average in the 1960s and 1970s of a little under 18 percent, according to Mr. Lindsey.

By contrast, when elderly and wealthy families are included, the debt service burden for all households fell last year to 16.2 percent, only slightly higher than levels in the 1960s and 1970s.

Economists like Mr. Lindsey are worried about Americans like Jim Rice, a 39-year-old veterinarian in Cynthiana, Ky., who complains that his income has not kept up with rising prices, especially for cars.

Mr. Rice refinanced his home last year with a larger mortgage and used the extra money to buy an $18,000 Oldsmobile Bravada.

"What I save is my retirement plan, and that's zilch," Mr. Rice said.

For middle-class Americans like Mr. Rice, wages and salaries have stagnated. But rising financial markets and government assistance programs, like Social Security and Medicare, have increased the incomes of the affluent and the old.

So while debt payments have fallen as a share of the rising incomes of the rich or old, the share remains high for middle-class families. At the same time, low interest rates have encouraged millions to increase their mortgage debt and use the extra cash for consumer purchases.

Some prominent academic and Wall Street economists agree with Mr. Lindsey's concerns.

"The rate of consumer spending is not sustainable unless there is a noticeable pickup in the pace of income growth," said Michael J. Boskin, who was chairman of President George Bush's Council of Economic Advisers and is now a Stanford University economics professor.

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