Yesterday I posted
comments by Rick Davis of the
Consumer Metrics Institute about the latest BEA release on Personal Income and Outlays. One of Rick's observations triggered an interesting email from Paul Hanly, a 20-year veteran in banking and finance in Australia. Paul had experience in major corporate workouts after the 1992 recession and commercial real estate bust in Australia.
First Rick Davis's comment on U.S. personal savings:
The U.S. personal savings rate (as a % of Disposable Personal Income in the NIPA tables) was 5.9% in July, down from 6.2% in June but still above year-to-August 30, 2010 averages and likely to cause personal savings for 2010 to be at the highest rate since 1992. This is in spite of Vanguard's Prime Money Market Fund yielding 0.03% YTD, two orders of magnitude less than the rates available during the summer of 1992.
Now here is Paul's speculation on the underlying motives for personal savings:
The relevant interest rate to most borrowers isn't what a money market fund is offering. Consider the people in these three categories:
- Most people in the US have personal debt including an average of about USD 5,000 credit card debt. In Australia this debt would be at about 18% and would not be tax deductible. Savings includes debt repayment.
The effective pretax interest rate for credit card payment (18% not deductible) is about 25% pretax.
That is the best return on investment virtually anyone can get — and with absolute security!
Then there are the personal loans, car loans, store cards, mortgage loans, including home equity loans, business overdrafts, etc. These interest rates are the incentives for people to save.
- Small business owners illustrate another situation. They are solvent but under pressure from banks to reduce gearing. They don't have any option but to save (by repaying debt) with most free cash flow from their businesses.
If they don't repay, the bank puts them in default (maybe they are already in default paying a default rate, or their loan has expired, not been rolled over and been transferred to being an overdraft.
Their default may be because their home was used as security and the drop in home market value for borrowing purposes has put them in breach of borrowing covenants and forced them into default and paying say 2% higher than say 8 or 10% whatever their small business loan rate was.
- Another important group are those with college loans. I don't know the tax deductibility or interest rates on these, but they would be motivating anyone with college loan, or a housing loan taken to pay college fees.
These are the key situations that are driving saving by debt repayment for, I would say, 80% or more of people.
Thanks, Paul, for your thoughtful response!
