America’s middle class is already burdened by a trifecta of economic pressures: the labor market is slowing, household debt burdens are reaching new record highs, and interest rates have been creeping higher for most of this year. Now comes a distressing new report from the Mortgage Bankers Association, which reported yesterday that delinquencies on mortgages rose sharply in the third quarter of 2006.
Delinquency and default rates on loans and personal bankruptcy rates are still at comparatively low levels—only 4.7 percent of all loans in the third quarter—but they have been rising rapidly over the course of this year. Other measures of financial distress are also pointing one way for American families—up. With all pieces of the trifecta staying in place, rising delinquency rates on mortgages may be the beginning of a trend toward more middle class financial insecurity.
The labor market has been sub par over the last few years. Job growth averaged an annualized 0.5 percent per month for the entire business cycle, which started in March 2001. That is about one-fifth of the average of previous business cycles; only six out of 68 months of this business cycle posted job growth above the average of previous business cycles.
What’s worse, job growth has slowed since 2004. There were on average 175,000 new jobs each month in 2004, compared to 165,000 new jobs in 2005 and 149,000 new jobs in 2006—a drop of 14.6 percent since 2004.
Prices for important items such as housing, health care, transportation, and college education moved sharply higher over this same period. This combination of no or even negative income growth due to the weak labor market and increasing costs led families to take on record amounts of debt. Families on average owed the equivalent of 130.9 percent of their disposable income by September 2006.
The rise in debt levels went along with larger debt payments, despite generally lower interest rates. Families spent only 12.3 percent of their disposable income to service their debt at the start of the business cycle in March 2001, but this figure increased to 14.4 percent—the highest level since the Federal Reserve started collecting this data in 1980—in the second quarter of 2006, the last quarter for which data is available.
Debt payments could rise even further as interest rate increases make their way through the economy. Mortgage rates, for instance, rose from a low quarterly average of 5.7 percent in the second quarter of 2005 to 6.6 percent in the third quarter of 2006. Because many loans have interest rates fixed for some length of time, it will take a while before families feel the full effect of higher interest rates. Only when families take out new loans or if their loans are governed by variable interest rates, such as adjustable rate mortgages and home equity lines, will they see higher debt payments from higher interest rates.
Based on Federal Reserve data, I calculate that the share of variable interest rate mortgages rose to 25.1 percent in 2004, the last year for which data is available, from 15.9 percent in 2001. All signs indicate that the growth continued after 2004, which means that as more and more families face interest rate adjustments in the coming months, mortgage payments will increase.
The intersection of these disadvantageous trends is already taking its toll on middle class families. The Mortgage Bankers Association report yesterday showed that delinquencies on mortgages increased to 4.7 percent of all loans in the third quarter of 2006 from 4.4 percent of all loans in the first and second quarter of the year. The share of loans that were in foreclosure rose to 1.1 percent, the highest level since 2004.
Other measures indicate similar trends toward increased financial distress for America’s families. The default rate on credit cards grew to 3.9 percent in the third quarter of this year from 3.5 percent in the second quarter and 3.0 percent in the first quarter. These levels are below the highs of prior years, but are clearly rising rapidly.
The data on bankruptcy rates also show a worrisome trend over the course of 2006. Bankruptcy rates dropped precipitously in 2006 in the wake of large filings in 2005 just before the new bankruptcy law went into effect. However, from the first quarter of 2006 to the second quarter, the annualized personal bankruptcy rate, measured as bankruptcy cases relative to the U.S. population, grew from 1.5 in 1,000 to 2.0 in 1,000—an increase of 33.7 percent. The bankruptcy rate in the third quarter stood at 2.2 in 1,000, an additional increase of 9.6 percent in that quarter alone.
Middle class families are caught between low income growth, a high debt burden, and rising interest rates—and for the moment, these ingredients are here to stay. The most recent third quarter delinquency, default, and bankruptcy figures show that the dangers to middle class economic security are not theoretical concepts. They are a harsh reality for a growing share of middle class families.