Are Consumers Paying Down Their Debt?

Click on image for larger graphic.

Karl Denninger provides us with the chart above. It does not include the past few months of consumer debt reduction, but otherwise it tells the story. It is especially telling in terms of debt versus income. Does this debt level look sustainable?

And so now we hear that consumer debt fell at a 10.4% annual rate in July. That folks is six straight months of decline and 11 straight months of credit card debt decline. Five times the debt reduction economists expected.

Whether this is good news or bad depends (a) on your perspective and (b) on the reason for the reduction. Let me start with (b). According to the following link to Bloomberg, while debt was reduced the past couple of months, incomes declined slightly and spending went up slightly.

Now I am no math major, but how can debt go down if incomes went down and spending went up? The only answer I can think of is the fact that debt can be reduced in two ways. Number one, it is being paid off. Given lower incomes and higher spending, paying down debt seems unlikely in general. Number two, debt can go away by being written off, as in credit card defaults, bankruptcy filings and the like. I have seen no official stats on what caused the reductions but I suspect some reduction through defaults is a big factor here. Oh, and there is a third way, government stimulus is used to pay down debt, which is not to be underestimated in the present environment. Government debt replacing individual debt is not, however, a debt reduction. It may move debt to a lower rate and put off to another day the payoff, but it is not reduction.

Now the prospect that some, perhaps a significant, part of this reduction is people defaulting on debt is not good news from any perspective. Yet some of it may be due to people actually paying off debts and whether this is good also depends on your perspective. Some of it is likely due to tightening credit standards, leading to less credit with which we can grown debt and which leads to a forced reduction in debt. Reading between the lines on the Bloomberg link, the mainstream press, and undoubtedly the Administration, view this reduction in consumer debt as a negative. Low spending and more savings does not spell recovery for the economy in the short term.

Yet there are those of us who view the short, even medium, term as pretty much a lost cause. We have way too much debt and the only cure (correction) to our situation is to gradually reduce it. It took us an entire generation to build the debt to record levels and it may take longer to bring it back down as it was built by baby boomers who increasingly cannot afford to pay it off. If you question me on our debt load, this link may wake you up a bit. The graphic at the beginning of this post comes from it.

Sorry friends but until the debt situation is under control we have no recovery. We may stabilize at a bottom but we will stagnate there. I prefer to take the pain for a few years and do what we can to reduce debt so less is pushed off on generations to come, but that does not seem to be the Administration game plan. They seem hell bent on getting people back to their spending ways and on supporting the financial companies that got us into this mess. I am done for now standing on my soap box, but I am starting to percolate with anger on what is happening, so watch for more. The market being up is fool's gold in my opinion. There is nothing other than government stimulus around the world keeping us there.

Disclosures: None.

Comments

[derryl:]

I agree. We are in a financial environment that is naturally deflationary. There is more debt than can be serviced while maintaining a stable GDP so debt must be reduced. But if debt is reduced by savings and paydowns then circulating money supply and final demand shrinks (i.e. consumption) which shrinks business earnings which leads to layoffs which...we all know the deflationary death spiral.

A way to reduce systemic debt without deflating the economy into a depression would be a program of QE to replace the expiring debt-money with new non-debt money. I think we have reached peak debt so conventional, status quo solutions will no longer work. We can keep kicking the can down the road by replacing private debt with public debt but if we really are in a state of peak debt that means we are nearing the end of the road for can kicking.

Sep 09 04:44 AM

[User 353732:]

There are 4 ways consumer debt can be reduced
1. Repudiation partial or total, whether thru bankruptcy or wilful refusal to pay knowing that the financial and political cost of collecting by the creditor exceeds the value of the debt( much mortgage "reform" is obviously partial repudation backed by the coercive power of Big Government). Either way there is a write off. The former way implies imprudence or misfortune or sheer incompetence on the part of the borrower but not criminal intent. The latter way is, of course, indistinguishable from theft, and leads to an inexorable decline in the integrity of society and a lethal erosion in the level of trust. Contracts and credits are based on integrity and trust. Moral decline by the borrower leads to less willingness to extend credit by the lender.
To the extent that some notable portion of the debt was the result of misrepresentation and exploitation by the lender, there is a parallel moral decline in the lender making borrowers less willing to borrow. The combination of moral bankruptcy of both lender and borrower must, in the short and medium term, shrink the willingness to lend and borrow
2. Debt can be voluntarily paid down. In many cases this will lead to an increase in net worth and credit capacity of the consumer, which , after a lag may lead to increased spending and investing by consumers. There are other cases however, when such debt reduction, while morally laudable certainly, leads to no increase in the net worth or credit capacity of the borrower because debt far exceeds assets( millions of individuals and households are in this position today). Not only must the borrower's short term spending decrease to pay for debt service but there is also no ability to increase spending and investing even in the medium term. It may take such honest consumers a decade to rebuild their finances, by which time, behavior will have changed in favor of enduring frugality.
3. Debt can be paid off or assumed by someone else such as parents, friends, charities or Governments, unconditionally or with conditions on future borrowing and spending. Whether this is good or bad depends on the character of the borrower but such debt reduction is unlikely to lead to an aggregate increase in consumer spending. In many instances an unrecorded personal friends and family loan may be use to replace recorded debt so there is only "reported" but not real debt reduction.
4. Debt can be forcibily redeemed, in part or whole. via a seizure of consumer assets such as residence, car, boat, major appliance.
This kind of debt reduction will, generally, decrease the the long term credit capacity of the borrower and as the borrower must rely on cash flow rather than debt to finance consumption, this sort of debt reduction will lead to reduced overall spending.

Each of these mechanisms must take time: the process of voluntary and coerced adjustment to a greatly altered credit environment may well entail 4 to 8 years before debt outstanding is commensurate with the capacity to sustain and service it via increased incomes and/or increased asset values. Unemployment/underempl... does not increase income and loss of assets precludes participation in asset price inflation or appreciation. For scores of millions of Americans the old borrow to spend or foolishly invest or recklessly speculate days are not coming back.

Sep 09 06:12 AM

[Jiang Nan:]

Massive QE leading to less overvalued dollar may reinvigorate US manufacturing industry, which would cut import as well as boost export, that is of course if others stand still. Assuming that does lead to renew strength in US producing sector, it should lead to higher income down the road. That is the conventional view on a re-balanced global economy.

Question than would be if the saving is sufficient to provide for the investment requirement in the face of shrinking oversee investor funding (due to depreciating dollar).

Bottom line, appears to me a lot hinges on less over valued dollar.

Sep 09 06:25 AM

[lower98th:]

And about credit cards? What kind of system has the consumer, whom we supposedly need, paying 25% interest while the Fed floats the credit card lender with 1% money. As much as 75% (een more) of a delinquent credit card debt balance is NOT what was originally charged by the consumer, but the accumulated interest, fees, penalties, etc.

Can I get $240 if you spend $15?
Credit card math: Rate raised without notice from 9% to 25%, immediately raising $800 balance owed by unaware holder to $1,000 limit (and triggering interest start at purchase, not 30 days). Daily Starbucks coffee for a week, $3.00 each, pushes balance "over limit." Over limit fee: $37.00 on each "event" (5 days). Amount spent: $15. Penalties and fees: $185. Interest owed: $40.

And why is the consumer walking away from credit card debt?

Sep 09 06:38 AM

[CautiousInv...:]

Why is everyone surprised by this widely expected development and why is there uncertainty over how it's being achieved.

Comsumers saved $38.2 biilion during July, or around 4.2% of personal disposable income, and retired $21.5 billion of debt. On the surface, there is nothing to suggest defaults or writedowns.

Wait until the savings rate goes to 8% to 10%.

Sep 09 08:33 AM

[Tack:]

There is no such thing as "peak debt" in any economy in which GDP expands. One can argue that relative proportions are temporarily under- or overweight at a given moment, but debt can expand, ad infinitum, as long as the GDP does likewise at a similar or greater rate.





On Sep 09 04:44 AM derryl wrote:

> I agree. We are in a financial environment that is naturally deflationary.
> There is more debt than can be serviced while maintaining a stable
> GDP so debt must be reduced. But if debt is reduced by savings and
> paydowns then circulating money supply and final demand shrinks (i.e.
> consumption) which shrinks business earnings which leads to layoffs
> which...we all know the deflationary death spiral.
>
> A way to reduce systemic debt without deflating the economy into
> a depression would be a program of QE to replace the expiring debt-money
> with new non-debt money. I think we have reached peak debt so conventional,
> status quo solutions will no longer work. We can keep kicking the
> can down the road by replacing private debt with public debt but
> if we really are in a state of peak debt that means we are nearing
> the end of the road for can kicking.

Sep 09 10:21 AM

[NUCLEAR1929:]

they have to pay or go to jail, but the biggest criminal is us government that allowed banks to issue credit cards even to newborns

Sep 09 11:36 AM

[Joyful Alte...:]

Consumers can always spend to save: insulate the attic, buy a window air conditioner and avoid turning on the central air, buy seeds and a shovel and grow some food, things like that.

Sep 09 11:44 AM

[Mad Hedge F...:]

gyji. Consumer credit plunged by $21 billion in July, taking it down to the lowest level since WWII. The last time it was this low wartime rationing was in effect and a lot of individual purchases ended up in a booming black market. Instead of buying that new Cadillac escalade with the chrome wheels, they are paring down debt. Gun shy credit card companies are happy to take the money, and American express has been cutting back limits in zip codes with the weakest housing like California and Florida, even for current accounts. Banks have gone back to lending only to people who don’t need the money. The catatonic consumer is the main reason why I have not played equities from the long side since May, preferring instead to dabble in commodities. With 70% of GDP in shrink mode, any move up in the indexes is just fluff.

Sep 09 01:37 PM