Saturday, July 17, 2010

Financial Behavior: Then and Now



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Financial Behavior: Then and Now

Much has changed in America over the last one hundred years. Corporations have come and gone, Wall Street has had its ups and downs, and every year brings us a new standard for fashion in clothing. Additionally, the American mentality itself has shifted on almost every level from diet to finances. The average American has evolved in their philosophy of money and how they handle it. But is it a good evolution? Are we climbing the so-called evolutionary ladder, or are we getting caught up in harmful mutations? Or worse, are we de-evolving in our understanding of financial principles? To fully understand this, we must track our progress and see what the last one hundred years have brought us. How did our grandparents and great-grandparents handle money?

In 1910 the Sears, Roebuck, and Co. Catalogue contained the following line, “...buying on credit is folly.” (D. Ramsey, “Dumping Debt”, 2008) In 1922 Henry Ford, said in his book, “My Life and Work”, “…another rock on which business breaks is debt.” Later on he declared, “…most, would bestir themselves very little were it not for the pressure of debt obligations. If so, they are not free men and will not work from free motives. The debt motive is, basically, a slave motive.” (“Quotes by and about Henry Ford”, http://www.abelard.org/ford/ford4_quotes.php) These quotes give us a glimpse of the pre-1950 mentality regarding money. Debt was regarded as foolish, or even a sin (D.Ramsey), and many of that generation were fondly remembered for “saving for a rainy day” despite what they may have wanted at the time. In the 1930s during the depression there was in fact a negative savings rate, but it was largely based on the need to survive, rather than a desire for wealth and luxury. The Bureau of Economic Analysis in this year’s National Income and Product Accounts Table reports that the average savings rate after the Second World War was nearly 10%, and during the war it rose to as high as 16%. What this means is that saving was considered a necessary and prudent part of life by our grandparents, and our great-grandparents. It was simply the responsible thing to do. But the paradigm was already beginning to shift by the end of the 1950s.

In early 1958 Frank McNamara created the first credit card known as “Diner’s Club” (Wikipedia). After the war America had become prosperous and after pinching and hanging on by so little for so the long the desire to have their day in the sun was strong. By 1960 Americans had charged over $340 million of today’s dollars on their newfound credit cards. By 1970 the bill was 7 billion dollars spent via credit card, with an unbelievable 22% delinquency rate. (“Just one Word: Plastic” http://money.cnn.com/magazines/fortune/fortune_archive/2004/02/23/362195/index.htm) The credit card age had arrived with bang and it was almost instantly an industry measured in billions, not millions. The discipline was sliding away. The splurge had started.

Meanwhile, personal debt continued to steadily climb from 1950 to 1965 but began to taper off by the early 1970s. In the late 70s, the debt trend began to rise yet again, but still the ratio of debt-to-income was below 60%. What this essentially means is that for every $100 of income, less than $60 was owed in personal debt. All of this changed in 1985 when the average American owed more than 60% of their income to their debtors. Since then, the trend has increased, with the difference between monies owed and income received reaching an all time low of 0%. (“Is Household Debt too High?”, William R. Emmons, Federal Reserve Bank of St. Louis) Essentially, since the year 2000 Americans have owed just as much as they have spent, or more, and in 2007 Americans had a negative savings rate of 10%. (Ramsey)

Our nation is facing an enormous financial crisis, and these statistics show us the road that has brought us to where we are today. The big question now is “why?” and what does the future hold for our nation?

Between the years after the Second World War and the 80s the idea of personal debt became more and more accepted in the eyes of the public. The creation of the universal credit card and their sudden widespread distribution as well as concept of “keeping up with the Jones’s” began to permeate society. By the 1980s credit cards were fast becoming the norm, and the idea of saving was quickly becoming more and more nonstandard. Suddenly the buzzword of “rainy day” had been replaced by a new buzzword, “leverage” and the idea of borrowing money to get ahead was even being taught in colleges and universities. By the 1990s the new craze was “90 Days Same as Cash” and furniture stores and electronics stores were capitalizing on the fact that 70% of all same-as-cash accounts did not pay off in 90 days. (MoneyCrashers.com, “Stay Away From The “90 Days, Same As Cash” Trap” by Erik Folgate)

All of these ideas pushed an attitude known as “instant gratification”. Whether or not this was intentional was beside the point. The marketing message was still clear: you can have it now. The consumer may have started with the mentality of “I can”, but over time it has shifted to “I must”. Financing, and credit have brought previously unaffordable technology and possessions within our grasp. Humans tend to possess little self-control and the sudden ease of purchasing an item without cash proved to be a fatal combination. An example of this is seen at a simple fast food outlet, McDonald’s. Not very long ago McDonald’s did not accept credit or debit cards, and their average ticket was under $5 per customer. However after they began accepting debit and credit cards the average order total jumped to over $7 per customer. (Ramsey) Additionally CreditCards.com reports that as of September 2009, there are more than 1 billion credit cards actively in circulation around the world. In 2008, Visa, MasterCard, Discover, and American Express chalked up nearly 2 trillion dollars spent with their cards, an 800 billion dollar increase over 5 years. The long and short of these statistics is that Americans simply cannot say “no” and increasingly so as time goes on. It is this kind of mentality that has brought us to the place where more Americans declare bankruptcy every year than graduate from college. (PBS.org “Affluenza…Diagnosis” http://www.pbs.org/kcts/affluenza/diag/what.html)

What then does the future hold? Ultimately the marketplace has only aided the shift from responsibility of our grandparents to the instant gratification of our current generation. As the market has brought us newer cars, nicer houses, and more desirable goods, it has also brought us a way to attain these things instantly without any sense of actually earning the things we want. A free market can and does generate the most desirable goods and a great amount of wealth in the process. How that is handled is neither the fault of the goods or the marketplace, the responsibility lies solely at the feet of the consumer. The market will always rise to meet the demands of the consumer, and that the market delivers instant lines of credit and 90-days-same-as-cash only reflects on the consumer as being willing and ready to use such devices to afford luxuries that are perhaps beyond their means. Ultimately the consumer is the one with the buying power and it is their choice as to how they use that power. The last 45 years have been a slow road to financial depravity because of willful ignorance on the part of the consumer, but if educated the consumer could be a much greater force to be reckoned with. Our task is to clean up the mess we have made and teach the next generation what our grandparents knew all along: discipline and responsibility are the keys to true wealth.