The economy is doing just fine, according to recent government data, but consumers are declaring bankruptcy at a record pace, and that indicates an underlying frailty in the expansion.

In the first quarter, personal bankruptcies totaled almost 253,000, a record. In addition, several organizations have indicated that bankruptcies worsened during the spring and summer. Indeed, some evidence suggests credit card delinquencies have become particularly chronic.

Consumers' financial weakness would appear surprising in view of broad measures of economic performance.

The economy expanded at a robust 4.8% annual rate in the second quarter, the fastest growth in two years. And consumer confidence in August surged to its highest level since March 1990, four months before the start of the 1990-1991 recession.

Press reports have indicated the Federal Reserve was so concerned about an overheating economy that it was contemplating a 50-basis-point increase in the federal funds rate if growth didn't cool quickly.

Why have bankruptcies burgeoned when the economy is seemingly doing so well, and what are the consequences of this for banks and the overall economy?

Overleveraged households. One cause of the problem is that consumers have leveraged their balance sheets to unprecedented levels recently. Total household debt relative to after-tax income averaged 93.5% in the second quarter of 1996, up from 84.7% in the same quarter of 1992.

Some rise in the ratio of household debt to after-tax income was to be expected at this point in the cyclical expansion that began in the spring of 1991. As expansions age (and the current one is relatively old by historical standards) consumers have a tendency to become increasingly indebted.

As the business cycle lengthens, consumers have typically been willing to spend and borrow as much as possible in order to enjoy the fruits of the expansion. In addition, banks have typically been willing to lend as much as possible, since times are considered good and memories have faded of the last recession and the difficulties of loan workouts.

The household debt component includes all types of debt. Some argue that including mortgage debt may not be that meaningful because mortgage payments carry a distinct tax advantage over rent payments. Thus, consumers who increase their exposure to mortgage debt are in better financial health than those who choose to rent.

Therefore, the ratio of consumer installment debt to after-tax income may be a more appropriate indication of the degree to which households are leveraged. Unfortunately, this ratio indicates the same sort of overextension. In the second quarter of 1996, the ratio of consumer installment debt to after-tax income averaged 20.7%. As recently as the fourth quarter of 1992, this ratio was only 16.5%.

Weak paychecks. The dichotomy between gross domestic product and increasing loan delinquencies is explained by the trend in paychecks.

Inflation-adjusted weekly earnings in the first eight months of this year averaged $254.57. This was down 0.2% from 1992 and is the lowest since the series was started in 1959.

Such poor performance in this broad measure of the standard of living may seem quite incongruous at a time when 10 million jobs were created. The quality of the jobs, however, was quite poor, and total layoffs in the past three years have declined only marginally from the worst levels of the 1990-91 recession.

Moreover, in the last three years, layoffs totaled 8.4 million. This was worse than at any point since the recession of 1981-82 and well above the 5.9 million workers laid off from 1987 to 1989.

Thus, layoffs have remained at recessionary levels even though this expansion has entered its sixth year. Compounding the problem is that laid- off workers have been forced to accept new jobs at significantly lower pay.

In the last three years, 33.4% of laid-off workers were able to obtain another full-time job at equal or higher pay. This has hardly changed from 1991-92, when 30.6% of laid-off workers were able to obtain another full- time job at equal or higher pay. This means that in the last three years two-thirds of laid-off workers who were able to find permanent jobs were doing so at lower pay.

Banks' response. In the most recent three months for which we have data, consumer loans at all commercial banks grew at a modest 7.3% annual rate. As recently as the three months through October 1994, these loans had surged at a 17.8% annual rate. According to the Fed's first- and second- quarter lending survey, banks raised their standards for credit card and auto loans. These tighter credit standards were prompted by fears of repayment failure.

In responding to the Fed's survey, bankers also noted that consumers appeared to be exhibiting a reduced willingness to borrow. This too may have factored into the dramatic slowdown in consumer loans.

The delinquency rate on mortgage loans has not escalated nearly to the degree consumer loan delinquencies have done. Nevertheless, there has been deterioration. This helps partly to explain a sharp slowdown in the growth of real estate loans.

In the past three months, these loans increased at just a 4.0% annual rate, compared with 12.7% in the three months through February 1995. Demand for mortgages, however, was also dampened by a sharp rise in mortgage rates during the most recent period.

Looking ahead. The consumer loan problem has implications beyond banks and borrowers. A rise in consumer indebtedness and increasing default, which occurs in aging expansions, signals frailty in the economy.

Typically, the consumer financial position deteriorates to a point at which the economy falls into recession. Indeed, even the slowing increase in bank loans in the midst of such a situation strongly suggests that economic growth prospects are waning.

Thus, the longer-term U.S. economic outlook may be considerably more guarded than is generally believed. Indeed, this should be a reminder that economic expansions do not last forever.

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