Tuesday, November 11, 2008

Read this, then visit the Credit Card Payoff Calculator webpage and be dismayed.

Of Two Minds
Charles Hughes Smith
An Open Letter to President-Elect Obama:
The U.S. "Family Budget" and a Nation of Debt-Serfs
(November 10, 2008)

...OK, on to business. Mr. President-Elect, perhaps the best way to understand the nation's grave predicament is to look at the American people as a family and the U.S. economy as the "family budget." This simple analogy may lack the appeal of high-powered academic models, but it does provide a remarkably easy-to-grasp clarity into the core problem you and your administration must face: the family budget is completely busted by a shattering, unprecedented excess of debt.

Put another way: to get our national "family budget" in perspective, just take an average over-indebted, underwater, maxed-out-credit-cards-at 21%-interest American family and add 10 zeros to their monthly shortfall...

...Transferring private debt to the Federal ledger resolves nothing, and borrowing money to bail out irresponsible lenders and give debt-serfs slightly reduced mortgage payments will only set the day of reckoning off for an all too brief period.

The essential reality you and your team must grasp is that the entire era of low-interest, credit-bubble "prosperity" was a fundamentally bogus "prosperity". Mr. President-Elect, the sad reality is that as a "family" we have been borrowing about 10% of our entire GDP for years; it's as if the family budget was running a 10% shortfall/deficit which was "filled" each month with borrowed money.

If we consider the U.S. economy our "family budget," some $1.4 trillion dollars has been borrowed every year to cover the shortfall between earnings and spending. The truth is that every year of the "boom," American homeowners (or shall we stop being coy and say the truth, mortgage-holders) extracted $700-800 billion in real estate equity, and then added $300 billion or so to their credit card balances. Corporations and businesses also piled up astounding debt during this bogus prosperity, too, as did the Federal government.

Here is a chart which illustrates the exponential growth of debt in the era of bogus prosperity:

The spike to the left in this chart [below] is the Great Depression. As you can see, Mr. President-Elect, our current indebtedness makes the Great Depression excesses look like a mere amateur's warmup to the endgame we now face.

...Mr. President-Elect, adjusted for inflation, our "family debts" should have risen no more than 43% from 1993 to 2007. Yet they rose an astonishing 300%.

...For instance, just the interest on external Federal debt has risen from "only" $205 billion in 2005 to over $300 Billion for fiscal year 2009.

Those hundreds of billions are funds which cannot be spent on programs the "family" wants and needs. The U.S. is like a family so heavily indebted that they're borrowing more just to pay the interest on existing debt. Down that path lies insolvency...

...Borrowed money is never free, and the money you spend paying interest is money you can't invest in productive assets. You are literally enriching the debt owners and impoverishing yourself.

There is only one solution to the debt-serf "family budget": reduce spending, reduce debt, stop borrowing more and start investing savings in productive assets rather than squandering borrowed money on a super-leveraged, risk-drunk "financial system," failed insurance companies, etc.

These realities are not popular, Mr. President-Elect, but the sooner the American "family" gets splashed with the cold water of their impending financial ruin, the sooner they can adjust to that reality and a balanced "family budget" which doesn't shift the burdens of our excesses onto future generations.

Will it be painful? Most assuredly; but then national insolvency will be painful, too.

Now, consider this letter that Mr. Smith wrote to Obama in light of your own family budget. The interest you are paying on credit cards and consumer loans is money you could be spending on other things. Your situation is no different than that of the Federal Government, which is why this analogy works both ways. If you're only making minimum payments on your cards and debts, you will literally spend decades paying for stuff you have no doubt already finished using long since. At 21% interest rate on your card or loan, every four years and a few months you pay in interest alone what you borrowed in the first place - and only a few dollars of that minimum payment goes to repay the actual amount you borrowed.

I strongly urge you to go to this webpage and enter the balance, interest, and payments you have been making on your cards and loans and see for yourself how long it will take to pay off at the rate you're going. I have no doubt you will be quite dismayed to see it.

Credit Card Payoff Calculator

In order to pay off your credit cards and consumer loans in a reasonable amount of time, you have to pay well more than the minimum payment, class. This leaves you with two options.

One, dip into savings to pay off your debt, then put the money you were paying towards your credit cards and loans back toward building up your savings. This is what I recommend. Being in debt costs you far more than you're earning from your savings and investments. If you have any assets that will get you out of debt, this is by far the best course of action.

Two, if you don't have any savings or choose not to utilize them, you will have to reduce spending in other areas to increase the monthly payments on your credit cards and consumer loans.

If you're not sure how to do this, I recommend an old post:

Budgeting for Beginners

If you have any questions I'll be happy to give them my best shot. I feel strongly that getting out of debt is something that should be above all other priorities except your mortgage/rent and food/medicine. Once you've gotten out of debt, you can add some things back in and live far more comfortably within your means than you possibly can with mountains of debt hanging over your head, class. Think about the quality of life that you are losing by having to pay interest on your debts - then do something about it!

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