Outstanding Consumer Credit Decline Does Not Indicate Less Use of Credit

 |  Includes: AXP, DFS, MA, V
by: John Lounsbury

David Rosenberg, chief economist at Gluskin Shell, Toronto, has an item in Breakfast with Dave that points out there has been a two year decline in outstanding consumer credit. Rosenberg provides the following two graphs: (Click to enlarge)
Click to enlarge
Click to enlarge
Outstanding credit card balances have declined every month for two years. Consumer credit (revolving and non-revolving - mortgage debt not included) has declined for seven months in a row and 21 of the last 24 months.

Since January, 2009 Consumer credit has declined by $160 billion. Most of that decline is in revolving credit, down $145 billion. During the same time period Steven Hansen has pointed out that personal consumption expenditures have increased by $450 billion. The same article has data showing that total personal disposable income has increased by $62 billion.

As a first pass estimate, let's add the numbers: $450 billion - $62 billion = ~$388 billion increased use of credit. Yet credit has declined by $160 billion.

The implication is that defaulted credit since January, 2009 is $388 billion + $160 billion = $548 billion, minus, of course, any debt that was actually paid off. However, retiring debt would consume disposable income so the $388 billion use of new credit would have been increased to offset the reduction in the $62 billion disposable income that could be applied to new purchases.

Consumer credit defaults in the past 20 months appear to total more than half a trillion dollars! That is about 20% of all outstanding consumer credit. Do you wonder why credit card companies have been raising rates? Here is a good reason. With 20% defaults in 20 months, the annual default rate is about 12%. Assuming the net the card company receives from merchant fees averages about 2% after deducting card holder incentives, the credit card company has perhaps a 10% "load" before even adding operational costs.

Perhaps the break even point for credit card issuers today is at least 15% charged interest on unpaid balances. A solution to this problem would be for the credit card companies to exercise better credit screening. However, based on advertising, it seems that credit qualification seems still to be performed with a mirror. If the applicant can fog the mirror, the card is approved.

Disclosure: No positions.