The Common Thread Between the Housing Collapse, the Euro Crisis and Millions of Americans – Debt

It’s amazing when you think of it.  Virtually every major financial crisis of late has involved some sort of issue with debt.  And there are millions of financial crises brewing in American households too:

• The US housing market collapsed precipitously.  No, not because Goldman Sachs sold a complex derivative to European clients which is garnering all the media attention these days, but because of lax underwriting standards and the realization that homeowners were unable or unwilling to repay their debt.
• Greece unraveled taking the rest of Europe with it because of two types of debt – existing debt that the world viewed as unlikely to be rolled over at reasonable rates (I called it here)…and the debt of future obligations to a massive public sector without enough future tax revenues to cover.  With the likes of hairdressers getting a government-sponsored FULL pension in their 50’s for life because it’s considered hazardous work (Ouch, those nasty chemicals), it’s no wonder that creditors/investors (endearingly referred to as a pack of wolves by European leadership) scoffed at the initial modest austerity measures and said “no way, show us more cuts”.  Tax evasion in Greece is so pervasive that while only 300 swimming pools were reported, satellite imagery estimated there were actually 17,000 in an area that requires increased tax payments.  Greeks are now resorting to covering their pools with tarps to avoid the satellites rather than just paying the tax (CNBC).  This type of behavior and sense of entitlement coupled with the street protests over austerity measure has not helped the case for the bailout of first, Greece and now, the Euro.
• US Households aren’t exactly the poster-child for fiscal restraint from either standpoint – existing debt or future debt obligations.

Do You Need an Austerity Plan?

As uncomfortable as introspective self-assessment and criticism is, the answer for many people reading this is a resounding “Yes”.  Similar to a government running a deficit during a recession which is then (in theory) supposed to be eliminated and turned into a surplus during boom times, many individuals and families rightly take on some long-term debt to fund say, a college education or a new home purchase with the thinking that over time, these debts are eliminated and benefits are incurred as a result of that upfront spending – i.e. higher income through a degree, a place you can call home with some potential for capital appreciation to boot, etc.

The problem is, much like western governments have done for decades, not only is there a deficit spending during recessions, but at all times good and bad.  So, in the individual example above, the debt doesn’t stop at a degree and a home.  It then extends into new car debt, credit card debt, buying a new flat-screen for no money down and no payments for 12 months.

Next, there’s the future debt obligations.  Similar to US states and municipalities making promises of lifetime pensions and healthcare for public workers, there’s just not enough future income to cover it.  Politicians are ignoring the issue and kicking the can down the road because the one who finally tries to turn it around has limited their chances of reelection (Governor Christie in New Jersey ring a bell?).  So, for individual Americans, these future obligations include retirement and your kids’ 529 college plan to fund before you know it.

Debt is a Universal Killer

We all know this.  We’ve had it pounded into our heads.  If you’re watching, you’re seeing it unfold before your eyes in the US and EU, while emerging economies continue to fund our lifestyles by buying our sovereign debt and storing as reserves.

What is it about debt that we just continue to ignore?  The Depression generation was notoriously frugal and cautious with their money – and many of them died multi-millionaires while living the life of a pauper as a result.  Meanwhile, subsequent generations have become increasingly liberal with their fiscal restraint to the point that we will be known by our progeny as the Debt Generation.

Some of the things that have likely contributed to the trend include how much easier it is to get access to unsecured credit these days, coupled with a new generation of young adults that grew up seeing how their parents didn’t live within their means.

What To Do About the Debt Threat

Just like our family’s doing, it may be high time to make a thorough assessment of current debt load and future obligations matched with a conservative estimate of likely cash inflows over time.  As ugly as the picture might look, have you taken out a canvas and painted this picture?