The Psychology of Consumer Debt

from Brett Steenbarger:
Popular personal finance expert Jean Chatzky calls it an epidemic and organizes self-help groups to deal with its impact. U.S. News and World Report, Newsweek, the Center for American Progress, and Fox News all use the same word to describe the situation: drowning.

Increasingly, they note, middle class Americans are drowning in debt.

Statistics from the Federal Reserve show that, from 1980 to the present, homeowners are paying an increasing percentage of their disposable income toward debt repayment. Indeed, the financial obligations ratio for the average American is at a record 19.4%. In an excellent review, Mike Shedlock notes that personal bankruptcy rates are rising among baby boomers and particularly among those above the age of 55. He refers to the situation of housing woes and rising fuel prices as a "perfect storm" of debt, with household expenses increasing and home equity not keeping pace.

To be sure, many causes of debt are unavoidable. Those without health insurance, for example, can be wiped out by expenses associated with treatment of major diseases, such as cancer. Many times, however, debt is simply a function of lifestyles that fail to balance income with expenditures. Chatzky's recent book on making money rather than excuses, for instance, covers a number of practical steps--simple reductions of regular purchases--that can meaningfully reduce a family's debt burden.

So what keeps individuals and families from taking such steps?

Consider these situations that appear quite different, but are psychologically similar:

* A man knows he needs to lose weight given his heart problems, but he continues to overeat.

* A woman vows to exercise to get in better shape, but fails to use the expensive equipment she's purchased.

* An investor knows that he should hold onto winning positions and not let losers get out of hand, yet he finds himself doing exactly the opposite.

* Arguments are killing their marriage; both members of the couple realize it and don't want a divorce, but they continue to wound one another in bitter verbal battles.

Each of these situations is one in which a person knows what to do, but cannot match their actions to their awareness. We usually associate such a lack of will with addictions, but as the above suggests--and as we see with many families in debt--the problem is much more widespread than that.

Why do we lack the will to do what is best for us?

The answer, one group of psychological researchers suggests, can be found in self-efficacy. Self-efficacy refers to the belief system of the individual: the degree to which people hold the conviction that they are *capable* of attaining their goals. A person may wish to lose weight, for example, but may not perceive that she is in control of her weight. Her belief is that "I just have a slow metabolism". Without the underlying conviction that she's in control, she won't be motivated to take the actions needed to change her situation.

Self-efficacy has been found to be associated with positive outcomes in educational and health settings, as well as athletic performance. When people believe that they *can* achieve a goal, they're more likely to initiate action toward that goal. A great example of how a lack of self-efficacy can dampen motivation can be found among abused children and spouses. Even when they have opportunities to leave their environments, they often do not act on these. They have learned--through painful experience--that they cannot control their own life outcomes.

So it is with many families facing potential bankruptcy. Their self-talk is that they're "in debt", just like they might be *in* an accident or *in* a hurricane. Such self-talk reinforces the notion that debt happens to them--not that they can influence their own financial outcomes. Similarly, the investor who hangs onto losing positions and risks going bust talks about being *in* the red, *in* losing trades, and *in* a drawdown.

Changing such self-talk requires fresh emotional experience, not just intellectual awareness. Intellectually everyone pretty much knows what they need to do to follow a budget, exit losing positions, stay in good physical condition, etc. If, however, you don't experience yourself as being in control, you can't internalize an enduring sense of self-efficacy. Building that experience of control requires at least two steps:

1) Developing a new kind of self-talk, which makes nouns like "debt" and "drawdown" into active verbs, stressing decision-making and choice. Debt is something you do, not something you passively find yourself in;

2) Cultivating a hierarchy of doable goals to create the emotional experience of being in control and seeing in one's own experience that it *is* possible to make good things happen.

In short, self-efficacy can only result from first-hand experiences of being efficacious. Unless we truly, consistently feel ourselves to be in control, we're unlikely to sustain the actions needed to achieve our goals. In my next post, I'll take a look at one immediate step people can take to generate those first-hand experiences of efficacy.