- The Washington Times - Thursday, October 28, 2010

A common refrain these days is that Americans are learning to save more and spend less, depending less on credit cards and unsustainable increases in mortgage debt to finance lifestyles that many can’t afford.

The unprecedented debt splurge of the past decade was a major cause of the financial crisis and recession, while the sluggish recovery is blamed on the hangover from that debt binge as consumers cut back on spending and try to pay off debt. Household debt has fallen by a record $900 billion since 2008, while the savings rate is up to a healthy 6 percent.

Although that sometimes painful but virtuous “deleveraging” process has been a boasting point for President Obama and other political leaders looking for positive trends in the economy, a closer look shows that it is not all or even mostly the result of moral rectitude and improved spending habits on the part of the public.

Rather than paring down what they owe, millions of consumers have simply stopped paying the bills, forcing banks to write off hundreds of billions of dollars in mortgages and credit card debts as uncollectible.

Defaulting on the debt, while not as commendable as paying it off, in the end produces the same statistical result once banks charge off the loans: lower debt, lower consumer spending and an increase in cash savings.

**FILE** Federal Reserve Chairman Ben Bernanke (Associated Press)
**FILE** Federal Reserve Chairman Ben Bernanke (Associated Press) more >

“Appearances are deceptive,” said Harm Bandholz, an economist at Unicredit Markets, who said that top officials at the White House and Federal Reserve have not entirely owned up to the ugly truth.

By Unicredit’s analysis, “the entire decline in household debt is attributable to a massive surge in loan defaults” and the resulting debt write-downs by banks, he said. “There is no deleveraging going on.”

Fed Chairman Ben S. Bernanke in recent testimony lauded the large increase in savings and reduction in consumer debt since 2008, saying that was necessary for consumers to “repair” their finances and eventually resume a more normal pace of spending.

Only in a footnote in his written testimony did Mr. Bernanke concede that “some of the reduction in household debt burdens is the result of defaults and write-downs rather than higher savings.”

But Mr. Bandholz said economic figures the Fed itself compiles show that, by his conservative estimate, banks have had to charge off as uncollectible about $425 billion in mortgage debt and about $200 billion in consumer loans — primarily from credit cards.

That accounts for most of the debt reduction in those categories reported by the Fed in the past two years, he said.

“There are two ways that debts can decline,” he said. Repaying the loans would be “the cleanest solution” for consumers and the economy alike, but instead people are forcing banks to resolve the problem by going into default.

By and large, “households have not yet begun to actively repay their debt,” he said, despite the “new frugality” often noted by the media.

An analysis by the Wall Street Journal last month also found that defaults accounted for most of the reduction in consumer debt seen since 2008.

Other analysts say it is difficult to know exactly how much debt is being repaid and how much is going into default and being written off as a loss by lenders. But clearly the share expunged through default is huge.

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