The Survey of Consumer Finances released by the Federal Reserve on June 11 revealed a surprising consequence of the Great Recession- credit card debt reduction. The number of families using credit cards dropped from 2007 to 2010, and the median balance on existing cards fell by 16.1 percent. This debt reduction was not without consequences, however.
Household Wealth Evaporated During the Recession
This positive reduction in credit card indebtedness was offset by the degree to which Americans lost wealth during the same period. Median family income dropped from $49,600 in 2007 to $45,800 in 2010, a decline of 7.7 percent. Even more disturbing is the dip in median family net worth, which lost 38.3 percent, from $126,400 in 2007 to just $77,300 in 2010.
The average credit card debt held by 46.1 percent of American families stood at $3,100 in 2007. In 2010, it was just $2,600. While the credit card debt reduction is a positive, this statistical finding is more likely to point to the number of bankruptcy filings that characterized the worst months of the Great Recession. Consumers, faced with rising debt, the mortgage crisis, and high unemployment opted for debt erasure in an effort to hang on to some aspect of their lives.
New Climate of Tight Credit
Unfortunately, lenders lost millions to both the mortgage bubble and the bankruptcy epidemic. Coupled with calls from the government to make lending practices more stringent, banks and card companies have tightened credit across the boards. Pair that with ongoing consumer reluctance to spend, and sluggish economic recovery and it begins to make sense.
Optimists insist that the upside to the credit card debt reduction even with the evaporation of personal wealth is that most consumers are in prime position to recover over the long-term. Analysts at the Institute for Social Research at the University of Michigan, however, found that a disturbing imbalance exists for one in five families. These Americans owe more on multiple forms of unsecured debt including credit cards than they have available in liquid assets or savings.
Debt Reduction at the Expense of Savings is a Mistake
At the end of 2011, approximately 23.4 percent of families have no savings compared to 18.5 percent in 2009. There is a strong indicator that personal finances may be holding the line on a day-to-day basis, but they are not improving. While paying down debt is always important, according to financial advisors, ignoring savings is a serious mistake.
The Federal Reserve Bank of New York tracked a decline in overall indebtedness in the U.S. of 0.9 percent for $11.44 trillion outstanding in the fourth quarter of 2011. That debt will likely inch back up, however, as consumer confidence slowly returns and the bulk of a family's available income goes towards living expenses over debt repayment and savings.
Although many Americans successfully dented their outstanding credit card bills during the recession, the bulk of citizens have not been able to save for the future and now live on greatly reduced terms. This raises the real specter of a generation of wage slaves, for whom retirement is not an option and who will be unlikely to pass on significant wealth to their children.
I have to say, I understand the desire to neglect savings when trying to eliminate debt. Debt looming overhead is really scary, why wouldn't you want to eliminate it as fast as possible?
Dave Ramsey, financial guru, though, recommends first saving up a "baby" emergency fund, and only once you save up that money, tackle paying off debt. And once the debt is paid off, you're supposed to build a bigger emergency fund, and then different types of savings. The reason Dave Ramsey recommends this is because if you don't have an emergency fund, you will go into debt again when emergencies crop up. The only way to truly eliminate debt is to take steps to stop going back into debt, and building a small savings is the way to do that.
How has the recession affected your financial situation? Have you developed debt? Paid off debt? Increased your savings? Decreased your savings? Do you match the statistics mentioned here, or no? What do you prioritize- saving money or paying off debt?
See my disclaimer.