Consumer Credit Contraction Shows No Sign of Slowing

The consumer credit contraction is now in its fifth month and shows no sign of slowing. In fact, the length and depth of the contraction has caught many analysts off guard and should weaken expectations of a consumer revival in the near-term.

According to Bloomberg, the credit contraction is the longest since 1991 and is a result of consumers not wanting to add to their already bulging debt burden. Consumer credit dropped $10.3 billion in June compared to $5.38 billion in May and there is little evidence to assume that this contraction will end anytime soon. While this certainly will impact consumer spending in the near-term it is better for Americans longer term as they will have less debt.

Economists had estimated that credit would contract by $5 billion, clearly the actual contraction was a surprising figure to most. Credit card fell by $5.25 billion while non-revolving debt, including auto loans and mobile-home loans, declined by $5.04 billion. Even though consumer credit has contracted government debt is sure to pick up the slack, to a degree.

I believe consumer spending declines have only just begun, but the current data shows a decline in spending by 1.2%. Personal incomes and real incomes have had steeper declines than most had expected and is probably a trend that will continue into the foreseeable future. Wages and salaries have also declines by 4.7% from June 2008 to June 2009, which is a record since the data has been collected.

With the markets and home values significantly lower Americans net worth has declined by $13.9 trillion which is just unbelievable. However, Fitch says defaults are falling for credit products and they believe we are close to a plateau on defaults. I have to disagree with that and believe that we will see higher than expected defaults in the near future, especially in the prime and jumbo mortgage area which has been trending higher lately. Not to mention that Fitch’s Prime Credit Card Index is 64% higher than it was just a year earlier at 10.79.

Consumers are stretched to the limit and that is bad news for GDP since we decided to become a consumer nation versus a manufacturing nation. While the rate of descent in credit defaults seems to be slowing I believe that it is the calm before the storm and the situation will still deteriorate. Based on what I see, which is beyond the headline numbers, there are growing, not shrinking, problems that have yet to come to light. Government spending will only create a short-term improvement before it is exhausted.