You work at a bank. A woman comes to borrow money from the bank. Here are the basics of her financial situation (admittedly incomplete, but in the ballpark):
She earns $140K/year after-tax. She’s a consultant and her job is very stable. In a really bad year her income might dip 5% (as it did recently), but it rarely increases by more than 3% in real terms. But, again, over the long term her income is quite stable. The current outlook is that her income will be basically flat for the next 5-10 years. She has been spending a bit more than her income for the last several years but says that she’s gotten this under control. She has $360K in debt. About half of that – or $180K – is a mortgage fixed at 4.5% for 30 years. She has no equity in her house, however. Although clearly there’s plenty of income to cover the mortgage. The other $180K in debt is a revolving credit line (interest-only) at 4% that matures every five years. The current five year term is up and she’s looking to renew it through your bank.
Now, from a collateral perspective, she doesn’t look too great – not much net worth there. On a cash-flow basis, however, she looks pretty good because her income is very stable and her ability to cover her fixed payments is good. Also, with a little discipline, she should be able to reduce her spending to a break-even level as well.
How do you feel about this borrower from an underwriting perspective?[/quote]
Everyone hit on some good points, but of course as we are, in fact, talking about Ms. America, there’s a deus ex machina (or few) to consider in this underwriting exercise…
First, the collateral issue is a red herring – only cashflow matters to our creditors (unlike a bank). Second, we can print money and raise taxes to pay our bills if need be, so our creditors will always get paid back, albeit the possibility of getting paid back in a currency of reduced value is a real (and growing) risk. Third, the dollar is the world’s reserve currency, with all that implies. And fourth, our major creditors have few other attractive “risk-free” alternatives – we’re one of the better houses (but not the best) on a very sketchy block.
So, yes, in a vacuum – sans the deus ex machinas – the US looks like a very weak credit. Probably can service the debt for quite some time, but not comfortably and there are some serious long-term issues. But when the full picture is taken into account, we’re still a weak credit – don’t get me wrong – but the situation isn’t as bad as it appears at first glance… which is one reason why our rates are so low (in addition to Fed shenanigans) despite our inherent issues.
So, in my view, we need to slowly reduce our considerable debt load (at the household and government levels) and the politicians need to produce balanced budgets, but… we’re not facing the End of Times from a credit perspective.
