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Spending spree over as Americans walk tightrope without safety net

Section: Daily Dispatches

By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, February 6, 2007

Americans are drawing down their personal savings at the fastest rate since the depths of the Great Depression, suggesting that U.S. household finances may be more fragile than they look.

The savings rate fell to minus 1pc in 2006 and has now been negative for 21 consecutive months, according to Commerce Department data. Such a rate was last seen in 1933, when a quarter of the American workforce was unemployed and whole families were kept alive by charitable soup kitchens.

There is no emergency to account for the slide this time. The U.S. economy is well into a long boom that has shaved unemployment to 4.6 percent, a phase of the cycle that should normally lead to a strong rise in savings.

Charles Dumas, chief strategist for Lombard Street Research, said a spending spree by rich Americans sitting on fat asset gains might have played a role, but the main driver was distress borrowing by households struggling to keep their heads above water as each source of stimulus dried up.

"There are no more tax cuts, no more house price gains, no more real income growth, and no more petrol price bonus," he said.

"Step 1 is to carry on spending because that is the divine right of Americans, and Step 2 is to run up second mortgages. But people are near the end of the rope and it's no surprise that sub-prime lenders are now getting into trouble."

The default rate on sub-prime loans reached a decade-high of 10.09 percent in November, according to a report by Friedman Billings Ramsey & Co. Some 16 lenders have already gone bankrupt, including California's Ownit Mortgage Solutions and Sebring Capital Partners.

The troubles are spreading to the capital markets where many of the loans are packaged together and sold as securities. These are then "insured" through the credit default swap market.

The ABX index that measures these swaps has dropped 5 percent over the last six weeks, a substantial fall for an instrument of this kind.

There are other ominous signs. A random audit in Virginia found that 60 percent of borrowers had exaggerated their actual income by more than half when applying for a mortgage, pointing to further skeletons in the closet.

Some $390 billion (E198 billion) in mortgages with adjustable rates, taken out in 2004 and 2005 when interest rates were far below current levels, are due to ratchet up this year, in some cases doubling payments.

Beth Ann Bovino, senior economist at Standard & Poor's in New York, said U.S. house prices were likely to fall 7 percent to 8 percent from peak to trough before bottoming out later this year.

"People are not going to be able to tap into their homes as cash machines anymore and the ratio of debt service costs to disposable income is now at an historic high of 18.2," she said.

"We're not expecting the economy to fall off a cliff but household spending is going to have to slow down."

Until last year Americans were subsidising their lifestyles to the tune of $70 billion a month through withdrawal of home equity.

This has since dropped to nearer $30 billion a month. The shortfall has been more or less covered by the falling savings rate -- so far.

The slide into negative savings could hardly come at a worse time, just as 80 million or so baby boomers start feeding into the retirement pool and prepare to draw down wealth. Large numbers could face poverty in old age. Yale professor Jacob Hacker said the average American was now walking a shaky financial tightrope, without a safety net.

"American family incomes are on a frightening roller-coaster, rising and falling much more sharply than they did thirty years ago," he said.

The welfare net of health care and pensions once provided by corporations is crumbling as a result of globalisation, leaving families to shoulder the risk. Prof. Hacker said personal bankruptcies had risen from under 300,000 in 1980 to more than 2 million in 2005.

Many were well-educated and with children. "They are not the persistently poor. They are refugees of the middle class, drowning in debt, and frequently wondering how they fell so far so fast," he said.

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