As another month draws to a close, and we send off another payment to our credit card company, Bryan in New Haven, Conn., has had a little daydream. What would happen if we all paid off our credit card balances -- in full, all at once?
I'm not an economist, but a fantasy scenario crossed my mind and I've been trying to puzzle it through: What would be the long-term effect on our economy if all U.S. credit card debt was paid off? ... Assuming we stayed debt-free, how would this affect the lenders, banks, and other businesses? … It would never happen of course, but it got me wondering.
Bryan L. --New Haven, Conn.
We get questions like this one all the time: what if we all got together and stopped buying imported goods? Or boycotted foreign oil or a specific brand of gasoline? Couldn't we all get together, like an enraged electorate, and "send a message"?
As you point out: it's not likely. When markets create a herd mentality, it's almost always a reaction -- usually sparked by fear or greed. Neither seems likely to motivate consumers to pay off debt.
In the case of a massive credit card payoff, a lot depends on where we all got the money to pay off the debt. (We're ruling out the prospect that lenders would decide to just let us all off the hook.) If people suddenly stopped all “discretionary” spending to pay off their credit cards, -- and stopped going out to dinner and the movies, skipped going to the nail salon, abandoned trips to the mall, and stopped shopping online for stuff we didn’t realize we had to have until we saw it pop up on the screen -- that would not be a good thing.
About two-thirds of the U.S. economy is based on consumer spending. So if we all squeezed our household budgets to payoff our debts, you would likely see a sharp decline in GDP and a huge spike in unemployment. Without all that spending, there would no need for millions of jobs – from the people who make the cardboard boxes to package all the stuff we buy to the people who work in the stores, restaurants and malls that make a living serving it up.
Even if we could all get to this “debt-free zone” unscathed, we’d still have to contend with an economy that was no longer lubricated by credit. Credit cards aren’t just convenient: they actually create spending power that is then used to buy goods and services. If you sucked all that spending power out of the system all at once, you’d risk creating a huge deflationary backdraft. Yes, people who still had jobs might have more to spend. But there would be much less spending power overall because many more people would be out of work.
Another way to fund this massive debt payback would be to tap the trillions in savings in stocks or appreciated home prices. But if credit card holders all tried to tap their paper profits at the same time, the stock and housing markets would be flooded with sellers, forcing prices to fall sharply. So that wouldn’t work either.
But assuming we all won some cosmic lottery at the same time, with some $2.2 trillion (and counting) of consumer debt outstanding in the U.S., any repayment in full would certainly send shockwaves through the financial services industry, especially if we all then vowed to remain debt free. Lenders can’t make money unless they lend. Watching those lenders come crawling back for more business might provide some short-term satisfaction to all of us borrowers – especially those of us chafing at ridiculously high credit cards rates and rapidly proliferating, completely unjustifiable “fees.” But an economy without a deep, reliable pool of credit wouldn’t get very far. As much as we all hate paying interest, we all need lenders even more.
This is not to defend the current high levels of credit card borrowing – nor the aggressive marketing by lenders to people who can ill-afford to take on more debt (delicately referred to in the industry as the “sub-prime” market.) Yes, everyone needs to borrow responsibly. But the credit industry needs to lend responsibly, too. Tricking people into signing up for “teaser rates,” unilaterally changing credit terms after the loan has been made, carpet bombing mailboxes with blank checks – these practices are no more responsible than the shopper who doesn’t know when to stop. (Remember: the reason lenders can afford to take the losses on people who don’t pay them back is by charging more to the people who do.)
The most important factor in all this is the rate of change in consumer debt – and the real income people generate to pay it off. If you get a raise and take new debt in moderation, you’re likely just using credit in place of cash. You can still “afford” the new debt -- at least until your pay is cut or you lose your job. If, on the other hand, the economy stalls and your income goes nowhere – but you keep maxxing out your credit cards to keep the party going – you’re going to regret it tomorrow when the bills come due and you can’t pay them off.
To many observers, the current rate of American savings seems dangerously low – and debt levels dangerously high. But we’ve heard the same warning several times in the past few decades. And the U.S. consumer, and the economy, seem to find a way to keep on going.
What happens to my stock when the company goes bankrupt? I didn't get out in time when Calpine declared bankruptcy. I had $4000 invested and now its only worth $1000. Should I sell while I still can or might it come back up? I don't know what to do!
Steve R. -- Tucson, AZ
We don’t give specific advice on individual stocks. We think people need to make these decisions for themselves and can often do a better job than the “pros” -- if they take the time to ask the right questions and do some research. Why is it that the same people who will spend hours, days or weeks researching the purchase of a new piece of consumer electronics can’t be bothered to apply the same critical selection process to their investments? (Maybe readers can help us answer that one.)
We can tell you that when a company comes out of bankruptcy protection from its creditors, it often leaves shareholders with nothing. After it “reorganizes,” a company pays off its debt holders first. (Usually, the reason a company ends up in bankruptcy court in the first place is that it’s got more debt than it can pay back.) As part of the process, the company usually issues "new" shares and then declares the "old" shares worthless.
If the “new” shares are used entirely to pay off debts, "old" shareholders like yourself (always last in line in these proceedings) are left with worthless paper. You won’t know for sure until the company announces, and the court approves, a reorganization plan. That negotiated settlement spells out which creditors get paid what. Since the company just took on $2 billion in new debt to keep going, it’s likely that those new debt holders will end up owning a big chunk of the “new” shares.
But you needn’t lose sleep about the fate of company’s board of directors. Last week, according to the Associated Press, Calpine's directors voted to give themselves big raises a week after the company rolled out a cost-cutting plan that will fire 300 employees, or about 9 percent of its work force.