The Neiman Marcus Paradox
How dumb rich people end up in debt.
One of the best scenes in Tom Wolfe's The Bonfire of the Vanities was when Sherman McCoy enumerated his expenses—the private school, the birthday party, the summer house, the jewelry, the taxes—and fretted that he was having difficulty making it on $1 million a year. And that was in the mid-1980s!
The rich are different than you and me. They shop at better stores, and they don't fly commercially. But in one way, they are very much the same: A fair number of them spend more than they make.
At the high end of American society, as at the low end, debt is apparently becoming the fuel of choice for the engine of consumption. Yes, most rich people easily pay for all their baubles. In last Friday's Wall Street Journal Robert Frank noted, "The richest 1 percent controlled 33 percent of the nation's total wealth in 2001, yet they held only 6 percent of its debt." But they still owe plenty. Frank cited research by Federal Reserve economist Arthur Kennickell noting that in 2001, the U.S. households with more than $5.9 million in net worth—the top 1 percent—owed $346 billion—most of it tied up in house mortgages. What's more, "borrowing among the richest Americans has grown in the past few years as interest rates have remained historically low."
Traditionally, debt has been associated with poverty. But in the modern age it has been re-imagined as leverage—a powerful force that lets you lift more than you otherwise could. And a big chunk of today's rich-folk indebtedness is surely related more to leverage than to an inability to pay current bills. Many rich people probably think (and rightly so, from experience) that they can get a higher return on cash than the interest they pay. Borrowing at 6 percent to pay for that ski house in Aspen is a no-brainer if you can earn 15 percent with your hedge-fund manager or by opening a new store.
But not all the rich folks' debt is strategic. Many high-end home-buyers, for example, are engaging in the same type of desperate maneuvers as hard-pressed middle-income purchasers. With prices rising, many first-time buyers in hot markets have turned away from fixed-rate mortgages to interest-only and so-called negative amortization loans (lower interest, no principal, and not even all the interest). James Grant, editor of Grant's Interest Rate Observer, noted with alarm an advertisement in the Wall Street Journal for interest-only loans with a negative-amortization option available for up to $5 million. Who is using these? "The rich who happen not to have money," he concludes.
And the rich are also capable of amassing idiotic debt. Frank cited a survey by Spectrem Group that found 14 percent of people with more than $5 million in assets have credit-card balances. That's mystifying, since credit-card cash is perhaps the most expensive form of money legally available.
For decades, Neiman Marcus has occupied an admirable niche as the destination of choice for extreme consumers. The department store chain was recently the subject of a fevered auction, and one of the most desired parts of the business, as the New York Times reported in April, was its private-label credit-card business. Neiman Marcus accepts only American Express and Neiman Marcus credit cards. The in-house card unit, which counts some 562,000 active users, has about $550 million in receivables—meaning about one-sixth of the company's 2004 sales was bought on layaway. In Connecticut, the interest rate on a Neiman Marcus card is a whopping 15 percent. Now, it could be that many of these borrowers are New American Luxury-types, middle-income fashion victims who buy groceries at A&P but splurge on shoes at Neiman Marcus. But a lot of these card-holders could simply be rich people who are either living beyond their means or have atrocious money-management skills.
We know from recent experience that the very rich can be just as reckless about aligning monthly cash flow with obligations as the poor. And we know that income volatility, one of the factors that push lower-income workers into debt, can affect those in the upper tax brackets. Bernard Ebbers of WorldCom borrowed hundreds of millions of dollars from the company he ran to buy ranches and a boatyard—and had difficulty paying it all back. When Enron's stock plunged, ex-CEO Kenneth Lay was forced to hold an asset fire sale to meet loan obligations. These may be extreme examples. But I'm guessing there are plenty of rich folks who need a sit-down with Suze Orman, or a copy of Jean Chatzky's Pay It Down.
Daniel Gross is the Moneybox columnist for Slate and the business columnist for Newsweek. You can e-mail him at firstname.lastname@example.org and follow him on Twitter. His latest book, Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation, has just been published in paperback.
Photograph of Elle Macpherson by Getty Images.