Deleveraging or Defaulting: Whither the Consumer?

Includes: DIA, QQQ, RTH, SPY
by: Old Trader

I think that we can all generally agree that the consumer is still THE main driver of the US economy. Therefore, whatever actions the consumer takes will, in large measure, dictate how the economy will perform in the future.

As many economists and pundits much smarter than myself have pointed out, one of, if not the biggest headwinds to a complete recovery, is the mountain of debt confronting the average consumer. Its pointed out that as consumers deleverage, consumption, and by extension, ultimately production, will decline, or at least increase at a less than robust rate as this deleveraging takes place.

Fine...this seems to me, at least, a pretty simple, straightforward proposition.

Looking at the term "deleveraging", especially as it would apply to the consumer, I immediately think in terms of hunkering down, cutting expenditures to the bone, stop using credit cards, and using every spare dime to pay down credit cards, and other debt. Indeed, last year, according to, outstanding credit card dropped by $93.2 billion to about $876 billion, NSA.

So far, so good.....this plays into the thesis of consumer deleveraging. Of course, this brings up an interesting question, at least to me. Things like retail spending numbers have been something of an upside surprise, over the last few months. Even taking out the more volatile components, such as energy and food, the numbers are what could well be called pleasantly good news, especially if one is of the opinion that the worst is behind us.

If only that were true, but there seems to be something of a fly in the ointment. Odysseas Papadimitriou, of CreditHub, by drilling down into the Federal Reserve data, discovered that during the same period, charge-offs on credit card debt totaled $838.3 billion. The bottom line is that roughly 90% of the decline in debt was the result of default.

This goes a long way in explaining how, faced with a weak job market, flat income growth, and the absence of the "home as an ATM", the consumer can still be spending at a surprising rate. Rough calculations show that the minimum payment of $20k of credit card debt is going to be somewhere in the neighborhood of $600/mo. By walking away from the debt, that amount of cash is now freed up for other purposes.

Way back when, there seemed to be a "hierarchy" of consumer debt. The mortgage was sacrosanct. If times got tough, credit cards were the first things to go by the board. While they're certainly handy to have, they're also fairly dispensable. The next rung, up (or down) was the car payment. After all, it IS usually hard to get to work, if your ride has been repo'ed. Only under the most dire of circumstances, did people fall into arrears on their mortgage payments.

As we all know, that hierarchy has been turned on its head, as foreclosures, jingle mail, etc., have grown by leaps and bounds. Doing some simple "sums", if a consumer defaults on $20k of credit card debt, and has stopped paying his mortgage (with the bonus of being allowed to stay in the home, as the foreclosure process drags on), $600 of CC minimum payments, plus, say $2k/ mo. of mortgage payments, means that the consumer now has at least $2600/mo. in "free cash" to spend (assuming, of course, that they still have a job).

That would go a long way in explaining the "strength" in retail sales.

This article was written using data from Market Watch

Disclosure: No positions