Melanie Kovacs is as all-American as one can be. Blonde and blue-eyed, with a winning smile, she works a quiet government job in the suburbs of Maryland while raising a baby girl by herself.

She likes to go to concerts in D.C. with friends, wonders if her daughter will start walking soon, and exercises regularly to get rid of her (largely imagined) excess poundage.

And like many other Americans, Melanie (not her real name) is climbing her way out of a quicksand trap of credit card debt and rising prices for goods, while trying to provide a good education for her daughter and a decent living for herself.

Melanie's solution was to refinance her new home in Maryland using a two-year adjustable mortgage, and cash out the equity to pay off her credit card debt.

"It got to the point where it felt like I was getting nowhere," she recalled. "I'd make these big payments each month, but the interest just kept getting bigger and bigger, so my debt never really changed."

By consolidating her debt via the refinance, Melanie is taking a risk, due to the possibility of her mortgage payments increasing, but she sees it as a good deal.

"My total payments will only be $100 more a month -- it's worth it to get rid of those awful credit cards, and housing prices in this area are just fantastic." Melanie plans to sell her home before her payments increase, counting on the continuing appreciation of homes in the D.C. area to offset her closing costs.

Melanie's story illustrates several key points about the American economy. Americans are carrying more debt on their backs than ever before, and are saving less and less money for the future. High gas and energy prices and record levels of credit card debt are frightening consumers away from spending more money, while the slowing housing market is putting an end to the frenzy of using "creative mortgages" and "bubble" pricing to cash out money from homes.

Pundits and statistics keep telling us that the economy is performing solidly. Growth is up, productivity is up, and stocks are bullish. Yet everyday people like Melanie have had to take drastic steps just to get out of the downward spiral of debt, often shifting their debts from one avenue to another just to ease the burden.

What's really happening to the American economy, and what can we expect down the road?

The Gas Price Seesaw

Drivers are breathing a sigh of relative relief at the pump, as prices for regular unleaded gas have fallen to a national average of $2.12, down from record highs of $3.50 and better circa Labor Day 2005.

Although the damage to Gulf Coast oil platforms from Hurricane Katrina is massive and will take many months to fully repair, many drilling rigs are coming back online and pumping millions of gallons of crude to eager markets.

Yet consumers are still angry over what they see as blatant profiteering by the major oil companies, taking advantage of the war in Iraq and America's worst natural disaster to pull in record profits. Many state Attorneys General are investigating claims of gouging at the pump, a charge that oil executives flatly deny.

This is not a new development by any means, as gas was topping $2 a gallon in early 2004. Jason Toews, creator of, a nationwide gas price monitoring Web site, correctly predicted that prices would continue to rise.

"Any time supply goes down, prices go up," Toews said in an interview at the time. "In the interim, it doesn't seem like we're going to see lower prices." Toews credited the increases in 2004 to OPEC's raising continual increases on crude oil prices, and low oil and gas inventories in America.

In 2005, President Bush was forced to tap the Strategic Petroleum Reserve in order to ease oil prices in the wake of Katrina, and the International Energy Agency released two million barrels of oil a day for 30 days after the hurricane struck. Once the reserve and emergency supplies are used up, there is every possibility that gas prices will climb to $3 a gallon again.

The instability of oil prices doesn't just affect how often we drive. Home heating costs are expected to skyrocket throughout the winter.

Households heated by natural gas are expected to pay $350 a month this year, an increase of 48 percent from 2004. Homeowners using oil for heating will be paying $378, an increase of 32 percent. The average American may be spending 20 percent of their take-home pay on energy costs this year, according to a Wall Street Journal report.

The one-two punch of high gas and heating prices has pushed many Americans to cut their holiday shopping and pull back from purchases in order to save money, which will cut into retailer profits and further darken the economic picture.

Many surveys and polling organizations have reported that Americans plan to spend less this holiday season. Retailers were forced to resort to massive discounts and early openings to get customers spending this year.

Using Homes as ATMs

One of the biggest growth areas for the economy over the last five years has been the real estate market.

Boom markets such as California's Bay Area, the greater Washington, D.C. metro region, and the greater Boston area, led sellers to frantically increase prices to astronomical levels, and buyers to use increasingly risky mortgages just to "lock in" and grab hold of a plum property.

Now there are signs that the housing market is cooling off. Inventories are increasing, sellers are cutting prices, and buyers are increasingly wary of taking a dip into the pool. Although a nationwide housing price crash seems unlikely, the slowing of home sales in major markets has analysts worried about the economy's reliance on housing to drive national output.

For many consumers, the biggest benefit of the housing boom was the ability of owners to tap their homes' equity via loans or lines of credit, essentially using their homes as ATMs to fund their spending and pay their bills. reported that equity cash-outs in Massachusetts jumped from 4 percent in 2001 to 14 percent in 2004.

In order to best take advantage of the astounding price appreciation of their homes, many owners followed the same route as Melanie Kovacs, and refinanced using a "creative" or "alternative" mortgage to the traditional 30-year fixed mortgage.

Interest-only mortgages, adjustable-rate mortgages (ARMs), and negative-option amortization loans have gone from arcane buzz phrases on realtors' lips to common means of financing homes. These mortgage products are all designed to take advantage of short-term interest rates, and with the Federal Reserve Board continually raising interest rates to combat inflation, many buyers are going to be in for a bad case of "sticker shock."

Although many homeowners used equity cashouts to buy expensive goods and take vacations, just as many did what Melanie did and used their equity to manage or pay off other debt, such as college tuition costs and credit card charges.

This may seem like a smart move in the short term, but with interest rates rising and the market cooling, the possibility exists that homeowners who refinanced with the intent to sell before the rates change may find themselves unable to move their house.

This can trap a homeowner in a home they can't afford, with massive debt still hanging over their head, and the threat of foreclosure in the future.

The reliance on home sales and equity to power the economy isn't just a case of regional "bubbles." The Economist reported recently that the principal cause for the housing boom didn't come from Wall Street or K Street, but from Beijing.

The emergence of China's army of cheap labor workers helped multinational corporations see much higher returns on investment and profit. Companies could pay workers less in America due to the threat of outsourcing, and buy goods made in China much more cheaply, leaving them flush with excess capital.

This capital was circulated back into the market in the form of "asset bubbles," specifically putting money into the real estate investment market.

The upshot is that the housing boom will last only as long as rates stay low and consumers can continue to spend, and as long as China is willing to continue to buy millions of U.S. Treasury bonds, keeping interest rates at record-low levels.

With consumer skittishness increasing along with short-term rates, as the Economist put it, "[t]he fate of American house prices could thus be determined by unelected bureaucrats in Beijing rather than the unelected central bankers of the West."

Credit Card Chaos

No overview of America's economy can overlook the enormous power of the credit industry. Card issuers and the banks they partner with have been claiming chart-busting revenue from the usage of plastic.

Visa recorded revenue of 2.4 billion in 2004, and scored a victory on "Black Friday" in 2005 through increased numbers of shoppers using Visa cards for purchases -- up 11.6 percent from 2004. Visa also leads the overall credit market, holding 53.9 percent of an incredible $2.7 trillion in overall consumer card charges for 2005 so far, according to

Those charges include $1.9 trillion in credit card charges, and $800 million in debit charges.

The high gas prices from Hurricane Katrina's wake created a windfall for card issuers as well. Credit card companies were bringing in almost $20 million a day from increased processing fees incurred when customers used their cards to pay for gas, averaging $2.2 billion a year, The Washington Post reported.

That's a lot of money to be throwing around, and most of the profit comes from late fees, over-limit-fees, balance transfer fees, and so on. As Melanie Kovacs found to her dismay, trying to pay off her Bank of America card was akin to running in place.

"Every time I charged something to the card," she recalled, "the charges would appear instantly, but when I tried to pay it off, the payments would always be marked 'late.' Even by just one day. Then I'd get hit with late fees, the balance would go up to the maximum, and they'd instantly switch my interest rate to something terrible!"

Melanie's story is all-too-common among cardholders, as we've reported so frequently this year. The average American carries $10,000 in credit card debt, spread out among as many as four cards, and each one of those is a plastic time bomb that can ruin a cardholder's credit rating, lead them to bankruptcy, and so on.

Why are we becoming ever more reliant on credit?

Many naysayers simply chalk it up to a lack of personal responsibility. "If they'd only live within their means and not splurge on SUV's and dinners at fancy restaurants, they'd be able to save more!" goes the cry.

There's a lot of truth to that. Many Americans are so driven by the "money equals happiness" mindset that they will finance themselves to the max just to keep up with the Joneses.

But just as many are using cards not for luxuries, but for basic needs such as food, clothes, child expenses, and health care costs. What has gone wrong when we're forced to use plastic to finance things we should be buying with cash?

It's all connected

Hale Stewart, a Houston, Texas tax lawyer and accountant, sees the American financial picture boiled down to a few basic elements -- "weak job growth, lack of meaningful upward mobility, and an explosion of consumer debt."

In his view, because "people are making the same [money] as they did five years ago," they've turned to things like credit cards and home equity to finance their lifestyles and cover basic needs.

Stewart, who regularly blogs on economic issues under the pseudonym "Bonddad," believes the American consumer is "almost maxed out on debt. Eventually they'll get to a point where they just can't take any more [debt] on, voluntarily or otherwise."

"The economy is standing up on sticks. Something's just not working right."

The economic "recovery" that armchair pundits have been crowing about has come at the loss of America's manufacturing base. 2.8 million manufacturing jobs have been cut in America since January 2001, and nearly 600,000 information technology-related jobs have followed suit. What job creation there is has been in specific areas such as housing construction and health care.

In fact, housing-related occupations such as realtors and brokers have accounted for almost 40 percent of the job market, according to Stewart. "When housing goes," he says, "we're gonna be in for some real problems."

Why aren't we saving more? Why aren't we putting money aside into retirement accounts, CD's, or just not spending it as soon as we get it? The answer, says Stewart, is the influx of cheap money and cheap labor from abroad that allows us to keep interest rates low, and enables consumers to finance large cars and larger homes using their equity and credit cards.

"Consumer spending accounts for 70 percent of gross domestic product," said Stewart. "If you could get something at an interest rate of 3 percent, what would you do? I know what I'd do -- I'd buy the damn thing!"

But, as the Gulf Coast storms remind us, the good times don't roll on forever. Eventually, the market will start to correct itself. All of America's major financing options, from homes to credit cards, are facing potential profit shortfalls and "adjustments."

The credit card industry, in particular, is in for a "perfect storm" caused by consumer defaults, natural disasters, and, ironically, by the very laws the industry worked so hard to pass.

Payback is Hell

Credit card companies and banks lobbied furiously to pass bankruptcy "reform" legislation for many years, and finally succeeded in May 2005.

The "Bankruptcy Reform and Consumer Protection Act" was a love note to creditors (and a pornographic e-mail to consumers), with its complex rules for filing, punitive financial restrictions, and mandated credit counseling that would cost debtors money and time. At the time, it seemed that MBNA had won the war.

However, Americans filed bankruptcy in record numbers to beat the implementation of the new law and get their cases heard under the old rules. 200,000 Americans filed bankruptcy in September 2005, prior to the new laws taking effect on Oct. 17.

Since all of those cases will be arbitrated under the old laws, card issuers and banks are expecting record levels of default. HSBC recorded an additional $100 million in defaults in the third quarter of 2005, relating to the bankruptcy filings.

In addition, the devastation from Hurricane Katrina caused many financial institutions to charge off high levels of loss. J.P. Morgan Chase alone recorded $100 million in losses from Katrina, while Capital One saw a charge of $44 million.

The credit industry is also facing more potential defaults from increased mandatory minimum payments, and many fed-up customers are simply paying their debts off and closing their cards faster. MBNA was so shaken by its cardholders' account closings that its profits fell by 94 percent, leading to its takeover by Bank of America.

If there is any positive news to take from America's grim financial picture, it may simply be that consumers are becoming more and more aware that we, as a nation, can't live on borrowed money.

People are waking up to the idea of saving more, spending less, cutting up the cards, and finding economic alternatives to gas-guzzling SUV's. Although Hale Stewart is pessimistic regarding the country's outlook, he concedes that "we're not over the cliff, but we're damn close to it...I've been dead wrong before."

Melanie Kovacs doesn't pretend to understand the ins and outs of economics, GDP, or housing bubbles. All she knows is that she is paying off her debt as quickly as she can and building a better life for herself and her daughter.

"I look at all that debt I accumulated and I think, 'What happened, man? Where did it all come from?" she says. "Now I'm just glad to be getting rid of it all."