Opinion : Middle class debt

My father is always complaining about how much debt my family is in. Now my father often complains for the sake of complaining, but a closer look does reveal a serious problem. My parents have a large debt load, with home equity loans, PLUS loans, and credit card debt that may never be paid off. They are currently floating by solvently with bad credit because of the continued presence of easy credit through refinancing. Furthermore, they live paycheck to paycheck and have no investments or retirement savings. But how did they get to this point?
To start with, they are not living beyond thier means. So many people facing bankruptcy are in the position because simply spent too much. This is also the case with people defaulting on ARMs, who have only themselves to blame for knowingly taking on larger mortgages than they could handle. This is not the case with my parents, however. They live in a modest house in a crappy neighborhood that was purchased over 25 years ago. Both of the cars they drive are used, one of which was a gift from my grandparents. They do not own any art or boats or serious luxury items short of my father's motorcycle, which he bought cheap from a friend and has likely appreciated in value. The TV's they own were gifts and their computer is 8yrs. old. They have not taken a proper vacation in over a decade and rarely go out on the town. They contribute little to their children's education (not even hitting their annual EFC) and anything they gave in the last few years has been through loans. Spending can not really account for their economic problems.
The next most common cause of financial hardship is a sudden unexpected event or situation such as losing a job, divorcing, or needing surgery. This does not apply either, although my parents have no security blanket for this sort of thing. They have been married for over 25 years and are both in nearly perfect health. They have steady incomes and have been employed continuously for years (over 30 in my fathers case). They have workers comp and health insurance. Dental surgery was needed a few years ago, yet the total cost was less than 10% of annual income, was financed interest free, and no disruption occurred. There are simply no discrete steps in my family's march towards debt. Indeed it has been a slow, insidious march over at least 2 decades.

So what can account for my parent's financial situation? Cases similar to theirs are often ignored by politicians, economists, and planners as unusual or complex. It is much easier to point to people who are irresponsible or unlucky to account for americans' debt problems. Yet there must be many more families that can sympathize, middle class people who do their best and don't get ahead. I am not an economist, but I have been putting some thought into what is causing my parents economic problems, so that maybe we can fix them, or at least I can avoid them in the future. There are 5 trends that stand out.

1. Lack of planning. This is most obvious when looking at their retirement and children's college situation. My parents were always content to live paycheck to paycheck, and simply did not put much money aside. In economic terms, they are exposing themselves to more risk. If your expenses and income are predictable, this works fine, however, this is rarely the case. If something comes up, say the water heater breaks, then the cost will need to be financed and interest payments will soon make small repairs into more costly situations. They have no retirement other than social security. This shows that longterm plans and risks were simply never considered or accounted for.

2. Lack of investment/financial understanding. I don't think my parents really understand how financial markets work. They have never made any investments that I know of, stocks, bonds, real estate or otherwise. Quite simply, if you don't have any assets that can make money, you will never get ahead. Professionals might wonder how any Americans aren't familiar with the economic system that holds this country together, but I would counter by asking: how would an average middle class worker learn about investing. This is not taught in schools, other family members are not much help, and financial planners are usually only interested in their own bottom line, not educating consumers. In fact, the one investment my parents made was to put my very meager trust fund (savings bonds from an aunt when I was born) into a mutual fund at the suggestion of M&T bank. My parents took the advice and put it all into a single fund, which managed to actually lose money (during the late 90's and before the dot com bust, mind you). After about 3 years, they simply put the money back into a savings acct. Adjusted for inflation, the trust fund was worth less when I got to college than when I was born. My parents are a representative case of the many Americans not benefiting from the investment prosperity that the economy is generating; when they have capital, they simply do not know how to use it.

3. Wages that do not keep pace with inflation. Steady employment is a wonderful thing, especially if you love your job, as both my parents do. Problem is, they are making less and less money at them. When me and my sister were born, my mother stayed home and raised us. In the mid 80s, my father's income was sufficient to support the family by itself. While I do not have (or will not disclose) exact numbers, he can't be making any more now than he was then. A family of 4 at my father's income today would barely clear the federal poverty line. While it is true that he works at the same level in the same job, inflation has destroyed his hourly wage, and devalued his now more experienced labor.

4. Inability to stick to short term budgets. This may seem like the easiest problem to control, but I believe it is more insidious than people think. Lets say that you plan to spent $100 for groceries each week and on average you go over this by $3. Now $3 does not seem like much and an extra box of cereal or bag of apples is hardly living extravagantly. But this can add up over time. That comes to about $150 a year (a week and a half of food), and over 20 years comes to over $3000 dollars. Economists would add opportunity costs such as the interest the money would gain in a savings account, but they do not go far enough. Let's say that the groceries are purchased with a credit card where the extra $3 raises the average daily balance. With a 12% a month compounding interest rate, those $3 extra dollars a week (even with occasional principal payments) can lead to thousands and thousands of dollars in long term debt. Spending an extra $20 on Christmas presents or not budgeting the gratuity for restaurant meals can have the same disasterous effect.


5. Not taking advantage of positive circumstances Economists and policy makers often assume that people will make rational decisions in their own self interest. This seems to rarely be the case, however. Sometimes non-economic factors are key. For instance, my father is a very low paid auto mechanic in an area with a high demand for that skilled trade. A glance at the classifieds reveals that he could increase his salary almost 25% by working for a dealer and over 50% working for a local bus company. The problem is that he likes where he works, the small business owner who employs him has been a family friend, and he has no intention of leaving. Be it idealism or lack of ambition, this irrational decision is a major contributor to long-term debt.
Other examples of missing positive circumstances may simply be out of ignorance. Someone who does not follow economic news would not know when interest rates are low and they should refinance, for instance. They recently took out a Upromise account that gains little interest because they did not want to give their credit card information to the company (if only they felt the same way about giving the credit card info to retail outlets…). Without positive financial events, the negative ones tend to stand out evven more.

I hope that this analysis will help me avoid similar problems in my life. Admittedly, I am off to a bad start, however. As I prepare to enter graduate school, I am facing more debt in student loans than my parents have amassed over the last 2 decades. My debt is on education, which carries no guarantees, does not build equity, and will not appreciate in value. Furthermore, it prevents me from acquiring and investing in things that have real value. My life will therefore serve to answer the question of whether education and fiscal intelligence can break the cycle of middle class poverty.