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Neiman Marcus knows that consumers love to spend money. That's why it recently began selling a $10,000

custom-designed mermaid suit.

But is all this spending getting out of hand?

The data say it is. After three years of low interest rates, consumers are awash in debt. Liabilities in the household sector have risen almost 12% in the last year, outpacing asset growth by a factor of nearly three, according to Merrill Lynch.

"There's a bubble all right, and it's in debt creation," said Merrill's chief economist David Rosenberg in a recent research note. "This economy has become so addicted to leverage this cycle that it probably wouldn't take much in the way of interest rate action to tip the economic scales the other way."

According to


data, which came out Friday, consumer credit grew at a 6.5% annual rate in the third quarter, up from 4.8% in the second quarter and higher than the 5.8% pace in the same period a year ago. In September, consumer credit rose at an annual rate of 9.75%. The data comprise both revolving and nonrevolving debt.

Mortgage balances have surged 14% in the past year, almost double the pace of real estate appreciation and household debt-to-net-worth ratios are now sitting near all-time highs of 21.5%. Just last year, this ratio was sitting at under 20% and at the end of the 1990s it stood at 15%.

Consumers got into this mess largely because the Federal Reserve cut interest rates to a 45-year low. This enabled consumers, whose spending accounts for two-thirds of gross domestic product, to purchase homes, cars and other goods with low financing charges and to take out cheap home equity loans.

Despite these high debt levels, most economists don't expect consumers to stop spending any time soon. But the high level of indebtedness could mean that the pace of spending will be modest going forward. Some restraint might already be apparent in earnings reports Thursday by

Wal-Mart and


"Debt is steep enough relative to net worth, and home prices are steep enough relative to wage and salary income, that we are limiting the upside potential for consumer spending," said John Lonski, senior economist at Moody's.

Lonski said he is looking for spending growth of about 3.5% next year because he expects the unemployment rate to tick down. That's up slightly from the expected growth of 3.1% this year but well below the 4.9% rate seen in 1999.

Ethan Harris, senior economist at Lehman Brothers, said an upturn in the labor market suggests there will be fewer defaults on consumer loans.

That would be good news for firms like






, which lend money to people with poor credit histories and have suffered from higher net chargeoffs recently. Chargeoffs are accounts receivable that will likely go uncollected.

Capital One

(COF) - Get Free Report

, which offers consumer and auto loans, and credit card issuer



have also been punished after posting disappointing earnings and earnings guidance.

Still, Harris is concerned that consumers simply don't need to buy anymore cars or homes and he is looking for consumer spending of just 3% next year.

"Defaults on loans tend to drop when the employment picture improves, but the accumulation of debt reflects a spending binge," he said. "People bought things that don't need to be replaced anytime soon, like cars, furniture and appliances."

Asha Bangalore, an economist at Northern Trust, is concerned about the outlook for consumer spending because she said it's not clear yet that the recent improvement in the job market is sustainable.

"We've only seen an increase in payrolls of 126,000

in October and we're not sure how much longer this will continue," she said. "Everyone is optimistic right now, but if these optimistic forecasts don't come true then

consumer debt becomes a serious issue."

Still, economists say a big dropoff in spending is unlikely. "We don't expect the consumer to suddenly shut off the taps because I don't think that's the way Americans behave," Harris said. "As long as income is coming in, there will be a reasonable amount of spending."

Harris also noted that consumer debt levels have never been a good indicator of what consumers will spend. "Debt tends to react to activity rather than cause activity, and the only time it matters is when it's cut off and banks change their minds about easy lending standards," he added.

Strong growth in the third quarter sparked concern that the Fed will hike rates sooner than expected. But economists say central bankers are cognizant of high consumer debt levels and won't raise rates until the economy has shown more sustainable signs of growth and the unemployment rate has fallen further.

"Fed tightening will only materially slow economic activity once rates hit about 2.5% to 3%," Lonski said. "That may not happen until 2005 and by then you may be looking at a faster rate of growth and employment."

Richard Berner, chief economist at Morgan Stanley, said concerns about the fragility of household balance sheets are "overblown." In his opinion, the most important measure of consumer debt is the debt service ratio, which shows how easily consumers are paying off their obligations. According to Fed data, this ratio is currently sitting close to a record high, but Bernstein believes the debt service burden is overstated.

The Federal Reserve seems to agree. In October, it introduced its financial obligations ratio, which it described as a broader measure than the debt service ratio because it includes things like auto lease payments, rental payments and homeowner's insurance. The FOR is also historically high, but has been dropping recently while the DSR has inched up.

Although the new gauge is a more accurate reflection of the debt burden, Berner said assumptions about debt maturities, interest rates and minimum payments still skew the estimates higher. "Neither debt nor debt service appears to be a legitimate threat to the American consumer," he said.