U.S. consumers cut back on borrowing by a record $21.6 billion in July. According to the Federal Reserve, consumer credit fell at an annual rate of 10% in the month. That’s about five times faster than the contraction that economists were expecting.
That’s great news if you’re a debt vigilante watching to signs that we’re finally going to give up our addiction to credit and live on what we earn.
It’s really bad news if you’re an unemployed worker looking for a job or an investor betting that the economy is in recovery mode.
If consumers aren’t adding new debt, they aren’t buying. And if they aren’t buying companies won’t be looking to hire the army of unemployed. The official unemployment rate hit 9.7% in August. Bad enough. Add in all the workers who are so discouraged that they’ve stopped looking and those working part time but who want to work full time and the rate is 16.8%.
Before the Fed reported the data on September 9, the consensus among economists was that consumer credit would contract by just $4 billion for the month. That relatively small contraction—on a total of $2.5 trillion in total consumer debt—was regarded as evidence that the economy had bottomed.
Apparently economists don’t open their own credit card bills and they underestimated the speed with which banks are cutting credit lines. A survey of bank loan officers found that 35.2% said they had “tightened somewhat” their lending standards. In real life, given the propensity of survey subjects to sugar-coat their answers, that means banks have been taking an ax the size of Paul Bunyan’s to credit card credit lines.
(Not to brag but I’ve had banks cut the credit line on two of my credit cards by 50% and 60% respectively. In the last two months. Beat that, if you can.)
Economists are somehow staying optimistic in the face of this plunge in consumer credit. I think it’s a tribute to the human ability to maintain two contradictory thoughts in the mind at once.
Economists surveyed by Bloomberg in the first week of August, predicted that consumer spending will grow by 1.5% in the second half of 2009 after growing by just 0.2% in the first half of the year.
They also believe that the jobless rate will average 10% in the first quarter of 2010. Let’s see, the jobless rate will go up from 9.7% to 10% and those jobless workers will spend more. Got it?
They also predicted that the economy will return to positive growth in the second half of 2009.
And that annual growth in consumer spending won’t hit 2% until 2011.
If banks keep cutting credit lines—and some banking analysts on Wall Street are projecting that consumer credit will drop by another 20% by the end of 2010—you can throw all those projections out the window.
I don’t think it is any big mystery why banks are not lending. Banks are taking huge provisions for loan losses and this reduces equity. As the banks lose equity their capital ratios deteriorate to where they drop below regulatory requirements. If you are a small bank and your stock price is in the toilet you can’t recapitalize by selling stock so the only way to quickly improve your capital ratios and leverage ratio is to reduce assets which are loans. So you cannot increase loans and improve your capital ratios at the same time.
It’s obvious why banks are cutting credit limits. This way when you exceed your credit limit they can add a penalty fee to what you own. If you follow the earning from credit cards you’ll see that they make most of their money from fees not from interest paid. It only makes sense, nobody gets cancelled for being over their limit, the bank just keeps tacking on fees.
Another sad but true tale that the 16.8% unemployment figure that Jim quoted isn’t taking into account is the “underemployed”. This is a segment of workers getting full time work, but its IT consultants who used to work for and are now working for Best Buy. Foreclosures are still on the rise…although as a student i’m seeing companies slowly start to hire again.
It is my opinion that the market overshot to the down side when the credit markets froze. The 50% V-shaped rally is just a return to a recession versus a depression evaluation. The big question is what happens next? Have we overshot on the upside, or is there more upside to go before leveling out for a long time?
Ya, ok, it is reasonable that the economy is not going to come back any time soon, cause the banks are not lending out their fake money..
Ok, explain why the stock market is up 50 % ~! Is the new normal a huge rally on bad news ?
I’m not going to fight the tape, but I have trailing stops on almost all my equity positions. We are one bad holiday season from a disaster. Back-to-School numbers weren’t impressive and I’m still breezing through morning traffic that is significantly less than last year. I’ll know when hiring returns by the amount of morning commuters packing the interstate.
I’m a believer of the “new normal” mantra.
Debt needs to come down. A recover can not be built on more debt or else the next credit crisis will make the last one look like a walk in the park.
great article
Well … I used to get, on average, 5 offers of new credit cards each month by mail. Now, it is only 1 every two months. That is OK with me. It is also OK that 2 credit cards informed me that they will close my credit cards (I did not use them anyway, but kept them just in case of emergency). I haven’t yet received any notice that the credit lines are shrinking on those cards, which I am using on a regular basis, but I also, for the very first time, haven’t received a single line increase notice, which is (or, better say, used to be) somewhat traditional.
Anyway, I believe it is is somewhat premature to say anything about spending until we hit the Christmas shopping season.
As an investor at Lending Club, which is for Per to Per lending, where one of the best reasons for using Lending Club is for someone to reduce the interest they pay on credit cards, I can tell you that the “they increased my interest rate to XX% and cut my credit limit, for no reason at all” is on a large amount of requests for loans to pay off the credit cards. And these are from people that have good to excellent credit.