On the surface, the U.S. economy looks like it’s doing fine. The unemployment rate is at an all-time low. Inflation—a popular measure of economic growth—is picking up. Consumer confidence is at the highest mark since 2004 but these “mainstream” indicators aren’t telling the whole story. We looked beyond the headlines to understand how the economy’s really doing and we found something disturbing in our research that almost no one is talking about this – but that could soon change.
Americans are filing bankruptcy at the fastest rate in years
Everyday Americans have racked up huge debts. U.S. households are more than $12.3 trillion in debt. Nearly 60% of Americans don’t set aside enough money to cover a $500 emergency. Last year, the value of U.S. auto loans topped $1 trillion for the first time ever. Outstanding credit card debt has also surged to record highs. The value of student loans has doubled since 2009.
Last month, 55,421 U.S. consumers filed bankruptcy. That’s 5.4% more than in January 2016. It was the second month in a row that consumer bankruptcies rose, too. In December, we had 4.5% more consumer bankruptcies than in December 2015.
This marks the first time in seven years that consumer bankruptcies have risen back-to-back monthly. After almost a decade of reckless borrowing, people are finally paying the price. They’re falling behind on their debt. They’re ending up in bankruptcy court and what we’ve seen so far is probably just the tip of the iceberg.
Why are everyday Americans borrowing more money than they can afford? Because living costs are rising faster than incomes. The chart below tells a story. The green line shows how fast the typical American household income has grown since 2003. The blue line measures how fast the cost of living has climbed over the same period and, as you can see, living costs are rising faster than incomes. Because of this, many Americans have borrowed money just to make ends meet.
A growing number of U.S. businesses are going bust
Last year, 37,823 U.S. companies went bankrupt. That’s 26% more than in all of 2015. According to Business Insider, consumer and business bankruptcies are now rising together for the first time in seven years. You can see this alarming trend in the chart below.
U.S. corporations have borrowed more than $9.5 trillion in the bond market since 2009. That’s 61% more than they borrowed in the eight years leading up to the 2008–2009 financial crisis.
Corporate balance sheets are now in far worse shape than they were before the last financial crisis. Just look at the chart below. It shows the cash-to-debt ratio for nearly 2,000 major U.S. companies. This key ratio has been falling since 2010.
We can’t say we’re surprised. After all, the Federal Reserve has been flooding the economy with cheap money for nearly a decade. It did so by holding its key interest rate near zero since 2008. This was supposed to stimulate the economy but all it did was encourage a lot of reckless borrowing.
The U.S. economy is not doing well
This wouldn’t be such a big problem if the economy were doing well but it’s not. The U.S. economy has grown just 2% per year since 2009. That makes the current recovery the weakest on record. More importantly, the U.S. economy hasn’t grown nearly as fast as consumer and business debt.
Interest rates are rising for the first time in years
The U.S. economy’s precarious situation could soon be put to the test. The Fed raised its key interest rate in December for only its second time since 2006 and the Fed said it plans to raise rates three more times in 2017.
That is a huge deal. Why? Because the Fed’s key rate sets the tone for rates across the economy. When it rises, mortgages and credit card rates rise, too, and that’s exactly what’s happened. The U.S. 30-year fixed mortgage rate has already jumped from 3.4% last July to 4.2% today. Rates on corporate debt, student loans, and credit cards have also spiked over the last few months. The higher rates climb, the harder it will be for people to pay off their debts.
Unless rates change course, we could see many more bankruptcies in the coming months. In other words, we could be on the edge of a full-fledged credit crisis.
Obviously, the Fed would do everything in its power to stop this. Maybe it will only raise its key rate once this year…or not at all. This might buy the economy time but it wouldn’t prevent the coming crisis.
The Fed can influence things like mortgage and credit card rates but it doesn’t set them, lenders do. Pretend you’re in their shoes. What would you do if bankruptcies were on the rise? You would probably issue fewer loans. On the loans you did make, you would also probably charge higher rates. This would compensate you for the extra risk you’d be taking on.
Now, imagine this happening on a grand scale. Credit would dry up in a hurry and our debt-addicted economy would start to unravel. That’s where we find ourselves today. Of course, we have no way of knowing if this is really the beginning of a giant bankruptcy wave. Only hindsight will tell but it’s something you should prepare for either way.
To get started, take a good look at your portfolio. Look “under the hoods” of the stocks you own. Make sure these companies don’t need cheap credit to pay the bills. If they do, get rid of them.
One way to get a sense of a company’s financial health is to look at its interest coverage ratio. This metric tells you how easily a company can finance its debt. The higher the ratio, the better. Generally speaking, avoid any company with a ratio below 1.5. These companies are already struggling to pay their lenders. If borrowing costs keep rising, they could default on their debt or even go bankrupt.
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