Now It’s Official: Consumers Are Hurting

It has been truly remarkable how consumer spending has held up, well, appeared to hold up, in the face of strong headwinds. Household debt to equity at record levels. Fewer refis to facilitate dis-saving as an illusion of prosperity. Home equity lines cut back. A deteriorating employment market (not-so-bad employment stats masking a fall in the number of hours worked). And the economists’ cheer that “inflation has not become embedded” translates into “just because gas and food cost a lot more, don’t expect a raise.”

The fact that consumers were continuing to rack up expenditures was seen as a sign of economic resilience, a sign that those who thought the US was in for a recession or a long period of stagnation were all wet.

In reality, the health of consumer outlays had already started looking dubious in April. While retail sales ex autos were up in nominal terms, on an inflation-adjusted basis, they were lower than the year prior.

But no economic trend is official until it is duly noted in the Wall Street Journal. Today, in “Pinched Consumers Scramble for Cash,” the Journal describes how consumers who have borrowed to bolster their lifestyles are now caught between debt service and ongoing expenses. The story focuses on measures taken by those in extremis:

As consumers max out their credit lines and banks clamp down on lending, many older and middle-class Americans are resorting to pricey, often-risky alternatives to stay afloat. Some are depleting their retirement accounts, tapping 401(k)s for both loans and hardship withdrawals. Some new fast-cash options allow homeowners to squeeze equity from their houses — without the burden of monthly payments. One new product offers a one-time payment. In exchange, the company shares in as much as 50% of any future gain or loss in the property’s value, typically collecting proceeds when the house is sold.

Americans are resorting to these more extreme measures due to the combination of dwindling jobs, falling home prices, shaky credit markets and a sharp run-up in food and energy prices….

Many people are resorting to more conventional means of borrowing: In March, consumers had a record $957 billion of credit-card and other types of revolving debt outstanding — up about 8% from a year earlier, according to preliminary data from the Federal Reserve.

But businesses are reporting greater demand for newer cash-raising techniques. Reverse mortgages are gaining new favor. Secured by a home’s equity, this vehicle can provide consumers with a lump-sum payout, a line of credit, periodic payments or a combination thereof.

Also flourishing: niche products that quickly unlock the value of a particular asset. Life settlements, once marketed mainly to the wealthy, have grown in popularity as companies target smaller policies….A number of companies cater to people who’ve won personal-injury settlements — which are often paid over a period of years — by buying them out up front, typically for a sum much lower than the amount of the payments sold. Reserve Solutions Inc. of New York offers debit cards to help workers access funds from preapproved 401(k) loans.

In life-settlement transactions, sellers….. often receive only about 20% of their policy’s face value. People who sell the rights to their legal-settlement payments often forfeit much of those payments’ value….

While 401(k) loans generally carry reasonable interest rates, individuals who take them lose some of the valuable power of compounded returns — jeopardizing their retirement security in the process.

Reverse mortgages often involve high fees and costs, which often add up to as much as 5% or 6% of the home value. A homeowner or his heirs must typically sell the house to repay the loan, which becomes due when the borrower leaves the home for more than one year or dies. So an owner who becomes incapacitated and needs an assisted-living facility for more than 12 months could face a huge balance due immediately.

Despite the risks, business in the fast-cash lane has been accelerating. In 2007, 18% of workers had taken a retirement-plan loan within the past year, up from 11% in 2006, says a recent survey by Transamerica Center for Retirement Studies. The number of federally insured reverse mortgages is also ticking up. From January through April of this year, lenders originated 40,068 such loans, compared with 37,020 in the same period last year.

The Financial Industry Regulatory Authority recently issued investor alerts warning consumers about the high costs of reverse mortgages and the opacity of the life-settlement market. More broadly, it also cautioned that some cash-now transactions could hurt consumers’ ability to qualify for certain benefits, like Medicaid. A lump-sum payment from a life settlement or reverse mortgage could leave an individual with too much cash to be eligible for such programs…..

Even the most financially savvy consumers are breaking some time-honed rules. Paul Herman, 51, is an attorney who represents consumers with debt and credit issues. He recently started a new law practice and went through a divorce. At the same time, his Boca Raton, Fla., house sat on the market for months without selling. With money getting tight, he went to his bank to investigate a business loan. But “with the rates I’d have to pay, it wasn’t worth it,” he says.

He tapped into his retirement savings instead, taking one loan and one taxable withdrawal. His logic: “Why plan for retirement if you can’t make it today?”