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'The consumer isn't overleveraged -- the middle class is'

August 14, 2009 | 10:00 am

The well-heeled might be able to save the U.S. economy from a long period of dismally weak consumer spending -- if only we don’t jack up their taxes.

That’s one conclusion to draw from a new Bank of America Merrill Lynch report this week, "The Myth of the Overlevered Consumer."

The report hammers home what you might already suspect: The consumer debt problem in the economy really is a debt problem for the middle class. The need to work off a chunk of that debt will sap middle-class families’ spending power for perhaps years to come.

By contrast, the upper 10% of income earners face a much smaller debt burden relative to income and net worth. Those people should have ample spending power to help fuel an economic recovery.

Using 2007 data from the Federal Reserve, BofA Merrill defines the middle class as people in the 40%-to-90% income percentiles. It defines lower-income folks as those in the zero to 40% income percentiles, and the wealthy as those in the top 10%.

Debtburden Lower-income families account for 40% of the population but just 12% of total consumption, BofA Merrill estimates. The middle class is 50% of the population and nearly as large a share of consumption, at 46%.

That leaves the wealthy to account for a hefty 42% of consumption.

In terms of their debt burdens, neither lower-income families nor the wealthy are constrained the way the middle class is constrained, the report asserts.

It estimates that middle-class families’ debt as a percentage of disposable income was 205% in 2007, a function of the level of trading-up during the housing boom and of the cash people pulled from their houses via home-equity loans.

By contrast, lower-income families’ debt-to-disposable-income ratio was a much less onerous 133%. And for the wealthy the percentage was lower still, at 116%.

Thus, the need to pare debt is most urgent now for middle-income earners.

What’s more, on the asset side, BofA Merrill says the middle-class has suffered more than the wealthy from the housing crash because middle-class families tended to rely more on their homes to build savings through rising equity. Also, the wealthy naturally had a much larger and more diverse portfolio of assets -- stocks, bonds, etc. -- which have mostly bounced back significantly this year.

Here’s how the report sums up the potential spending power of the three income groups in an economic recovery:

--- "The lower-income contingent makes up a relatively small proportion of income and suffers from a disproportionate share of unemployment, which typically lags the [economy] coming out of a recession.

--- "The overleveraged middle class -- heavyweight in share of total consumption -- is burdened by real estate losses that may not be recouped immediately, leaving them unable to lead a consumption rebound.

--- "That leaves it to the wealthy -- with modest leverage, full employment and witnessing a quicker rebound in their wealth -- to lead consumption higher."

Except, BofA Merrill says, if states and the federal government target upper-income-earners for higher tax rates that drain away disposable income.

What the report doesn't address is the question of what kind of recovery would be preferable, if we're able to choose: If you want a more broad-based rebound in consumption -- as opposed to heavy spending by the wealthy on what might be a relatively limited range of big-ticket goods and services -- doesn’t it make more sense to favor economic and tax policies that bolster the finances of middle- and lower-income folks, even if that’s at some cost to the better-off?

-- Tom Petruno

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