09 September 2010

Credit Cards Going Out Of Style

Consumer borrowing fell again in July as households cut back on their credit-card use for a 23rd consecutive month. . . Borrowing on credit cards fell by 6.3 percent in July after a 7.5 percent June decline.


As used here, "borrowing" means aggregate outstanding credit card debt. Thus, the amount of outstanding credit card debt in the United States has dropped by 13.3% in the last two months alone.

Overall consumer borrowing is down as well, by $3.6 billion in July, and about $80 billion in the last eighteen months, with declines in seventeen of those eighteen months (consumer credit got a 1% boost in January of this year), but this has been driven heavily by declining credit card use. Car loans started to rebound this summer, and total outstanding mortgage debt, which is the largest part of the total consumer debt load has declined, but much more modestly, despite record low mortgage interest rates.

We are close to reaching a point where half of consumers no longer use credit cards at all, something that six out of seven of them did in 2007.

“Credit card use among consumers decreased 31% between 2007 and 2009 (87% in 2007 down to 56% in 2009); if this rate of decline continues through year-end, credit card use will fall below 50%.” . . . The only debt that many households had half a century ago was their mortgages and in some instances their car loans.

From here

If this trend continues, we may be returning to the pre-credit card economic, with lower consumer spending levels in the short to medium term, and and a sharp downturn for the credit card industry.

This isn't entirely a bad thing. It is hard to deny that the record consumer debt levels before the financial crisis were too high. In many cases, people were living beyond their means, in part, based on asset bubble inflated home equity and investment asset prices.

On the other hand, credit cards have also had some positive economic impacts. They have allowed retailers to get out of the consumer debt business. Credit cards have provided a large share of the micro-credit level lending used to establish small businesses.

Credit cards have also provided a private sector safety net that can stabilize spending and avoid penny wise, pound foolish spending decisions (at a price far lower than that charged by non-traditional lenders like payday lenders, pawn shops and rent-to-own operations) for families with irregular income (such as the self-employed and commission based salespeople) and the temporarily unemployed, with a minimum of bureaucracy.

What is driving this trend? Some of the reasons include:

1. Credit card companies have increased minimum payment amounts (with federal government encouragement), greatly reducing the amount of debt that can be maintained at a given level of income.

2. Credit card companies have greatly reduced the credit lines that they make available to consumers on existing accounts, and have become much more cautious about giving people new cards. Simply put, it is harder to get credit.

3. Credit card companies have not lowered interest rates much (if any) despite record low interest rates in the economy as a whole, and inflation rates that are near zero and dancing with deflation.

4. The proportion of credit card debtors who are in default has soared to record levels, for a variety of reasons, including high unemployment, declining incomes for many families, and declining asset values. This explains, in part, the decision of credit card companies to tighten their loan underwriting and keep their interest rates high.

5. Bankruptcy law reforms passed in 2005 have made the perceived downside risk for middle class consumers of not being able to pay credit cards much greater.

6. Bankruptcy law reforms passed in 2005 tend to improve the relative position of secured creditors such as mortgage lenders and car loan lenders, and of alimony and child support creditors, relative to unsecured lenders like credit card issuers, despite the fact that it contains provisions favorable to credit card issuers relative to pre-reform banruptcy law.

7. New bankruptcy law reforms have not greatly improved collection rates for credit card debts that are in default. The "abuses" that were closed by the 2005 reform of the bankruptcy law, while galling at time to creditors, weren't producing big losses for credit card companies as a share of all uncollected debt.

8. Declining home equity and investment asset values, and a poor economy, have changed consumer perceptions of lifetime income and they have adjusted their spending accordingly.

We'll see how far this trend goes.


Michael Malak said...

Every time I make a credit card payment, the credit card company ratchets down the available credit. My credit lines are half what they were two years ago, despite a lifetime of responsible credit usage. This has caused quite a bit of trouble for me running a startup business. The title "going out of style" is thus extremely irritating to me, as it's been forced upon me.

Andrew Oh-Willeke said...

Fair enough. Accept my apologies for your irritation.

You are absolutely right that credit card companies and regulatory changes are primarily driving the trend, rather than a true change in consumer preferences (i.e. the change in fashion preferences that my somewhat snarky headline implies).

Too little caution has been replaced with too much caution, and it is both a real hardship for families and small businesses, and for the macroeconomy as well.