American debt nightmare ends easy credit era

The tightening of credit will force American families to cut their spending, mindful of their current paychecks instead of borrowing against future ones, said Frank Badillo, senior economist with TNS Retail Forward, a consulting and market research firm in Columbus, Ohio.

"We're going to see some fundamental changes in consumer behavior," he said.

Badillo and others compare the psychology to the way people reacted after gasoline reached $4 a gallon last summer. Prices have eased considerably since then, but consumers seem to have decided that the good old days of very cheap gasoline are over. In response, people have moved to buying smaller, more efficient cars, and trying to reduce the miles they drive. Demand for homes in outlying suburbs has declined.

Like gasoline prices, the availability of credit should improve once the current crisis eases. But consumers are confronting what some see as a long-term change.

After years of living off one income and drawing on credit to fill the gap, Portland, Ore., legal assistant Susie Shepherd and her partner, Kaite Chase, are rethinking their finances. In the past few years, they regularly ran up debt to pay Chase's tuition and repeatedly refinanced their home, pulling out equity to pay bills and drawing on lines of credit to cover expenses.

But Shepherd was caught short this fall when her brother asked for help in paying moving expenses. She tried to draw on a credit card, but found her line of credit had been cut in half. The only way to help, the couple decided, was to sell some household items.

"We'd been living on credit for so many years," Shepherd said.

Borrowing against the future has always been part of the American story.

"How did those religious English people get to this country on the Mayflower? They came on what we would call the installment plan," said Lendol Calder, author of "Financing the American Dream: A Cultural History of Consumer Credit."

But the Great Depression chastened consumers. After World War II, and the explosive growth of the suburbs, consumption rose sharply. But the modern era of easy credit really began with the deregulation of the late 1970s.

In a 1978 Supreme Court decision, banks won the right to charge whatever interest rate their home state allowed and to do so across state lines. States repealed usury laws capping interest rates. Banks began pursuing consumers in ways they hadn't before.

When inflation soared in the early '80s, banks aggressively marketed credit cards to struggling consumers as a good deal. The interest rates were high, but not as high as inflation. In the recession of 1990-91, banks who saw their profits tightening seized on the margins available by lending more to consumers. When Congress eliminated income tax deductions for interest on credit cards, banks pushed home equity loans, encouraging people to take money out of their homes to pay off the credit cards.

As families took on debt, they were encouraged to follow a rule of thumb: It's OK as long as you don't devote more than 25 percent of income to borrowing costs.

Lenders, though, found a way around that. The 20-year home loan was repackaged as a 30-year loan and lenders stretched three-year car payment schedules to seven, masking the extent of the debt load.

Consumers "think they're doing fine by their parents' standards," Manning said. "But boy, have they fallen far behind."

The industry came up with subprime loans in the 1990s, then used them to encourage consumers with checkered credit history to buy homes. When very low interest rates early this decade sent home prices skyrocketing, and Wall Street demanded even more lending to feed a market for mortgage-backed securities, lenders went into overdrive. Consumers could buy with no money down and no documentation of income and were encouraged to borrow against the rising value of their homes.

Before the housing bubbled popped, many consumers were pulling money out of their houses to pay for expenditures — from boats to big-screen TVs — well beyond ordinary living expenses.

Over the years, economists have tried to figure out when, if ever, consumers might finally reach their debt limit. But each time, Americans have proven far more resilient than pessimists imagined, financing their spending by borrowing.

The credit crunch, though, may be the breaking point.

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