Recently, Suze Orman announced what some have considered to be a stark reversal of her advice to consumers. Basically, on The Oprah Winfrey Show, she declared that people who do not have an emergency reserve should immediately stop aggressively paying down their debt (i.e., pay the minimum amounts only) and funnel any extra money into building up an emergency fund.

I'm not a huge fan of Orman, but I think she generally takes a saner view of things than many people, so I took a look at the April 3 Yahoo! News article that describes her position. I have to admit that her case is marginally more compelling that I initially thought it would be based on the quotes I'd seen on a few personal finance blogs – I suppose even PF bloggers are capable of proof-texting. Essentially, Suze believes that having cash available is more important than paying off debt because of the ever-decreasing supply of credit in the current economic environment.

"The sad reality is that the credit card industry is taking actions to protect themselves with no regard to your needs or how good you have been in paying your bills on time," she said, referring to the fact that credit card companies have been lowering credit limits, increasing interest rates, and revoking credit cards altogether.

That means that many Americans could find themselves without any access to credit following a job loss, when they need it most. If someone finds themselves out of work and without a credit card, then Orman worries about her ability to put food on the table. That is why an emergency fund is key, she says.

I don't think premise that "credit card companies are protecting themselves without regard" to customer action is quite right – I'm sure calculations for determining how much credit a bank extends to a particular customer is extremely complex, based both on individual activity and statistical data – but the conclusion is compelling. I have a great credit score at the moment (750+), yet I recently experienced a reduction in one of my credit card lines by half from $16,000 to an $8,000. This reduction doesn't really affect me since it was on a card I use rarely and always pay the complete balance, but I can understand how someone who doesn't have a significant amount of available credit would be concerned about the possibility of losing the little bit of a cushion that they do have.

So in that sense, having cash available does make some sense. But eight months' worth? That seems a bit excessive to me, and apparently to Trent at The Simple Dollar as well. He proposes a different, three-pronged approach to managing your finances in the current environment, which I've outlined through selective quotes below (his emphasis):

One, apply some realistic frugality in your life. I’m not suggesting completely revamping your life and completely altering your behavior - that will simply fail most of the time, just like a crash diet. Instead, look for truly effective ways to trim your spending, particularly things you can do one time and have them continually save money over the long haul....

Two, acquire no new debt. Instead of replacing things, stretch out their use a little bit longer or find alternate means. Take your credit cards and hide them, so you’re not tempted to use them for things you don’t truly need. Most importantly, take it one day at a time. Focus on just avoiding the credit cards in the here and now - don’t stress out about the long term.

Three, build up your emergency fund a little now, but be prepared to reduce it in 2010. If you’re really concerned about the short term, it’s okay to slow down the debt repayments in the short term. Just pay the minimums and put the extra payments (along with all of that other money you’re saving through the steps above) into your emergency fund. Then, when the economy rebounds and you’re clearly in a more secure state with your employment and other factors, don’t be afraid to put some of that savings towards your debts....

I think Trent's approach makes sense, despite the fact that I am not convinced that 2010 will be a much better year (he cites an MSN Money article that offers some speculation that the economy will turn around by then). I suppose that means that I think this approach is a good one regardless of the economic environment.

I'm just thankful that I just paid off the last of my long-term credit card debt with my state tax return, so now I can start building my own reserve. What, I didn't mention that already? Look for my next debt update next week. :)