Consumer Credit: The Next Bubble?

If there was a Wall St. zodiac, this year would probably be dubbed “The Year of the Bursting Bubble”. Late 2006/early 2007 saw the markets accepting the end of the housing boom, then we had the subprime crisis followed by Alt-a mortgages and the realization that we had a full-fledged mortgage crisis. On the corporate credit front, we were hit with the credit crunch/liquidity crisis and the end of the buyout boom. Judging by some recent events and the Q2 earnings reports of the retail banks and other major lenders, an overall consumer credit bubble may be next.

Revolving Debt Use

The months of May & June saw spikes in the amount of revolving debt carried by consumers, with increases of 12.2% and 8.4% respectively. At the same time, consumer spending was relatively stagnant which seems to indicate that people were using their credit cards to pay their bills rather than fuel consumption. Whilst credit card delinquencies have remained relatively stable, it does seem to indicate that people are going to slowly max out their credit cards and then fall behind on payments.

It was recently reported in the Wall Street Journal that banks are tightening their standards for credit cards and personal loans. When reading the article, these particular passages jumped out at me:

For the most part, lenders say the changes aren't directly tied to the mortgage mess, but reflect concerns about an economic slowdown and uncertainty about interest rates. Still, some lenders are becoming more cautious about extending credit in weaker housing markets and to people who may have exposure to certain riskier mortgages

[...]

A spokesman for J.P. Morgan Chase & Co.'s Chase says the company has been tightening up credit guidelines across some consumer products, such as home-equity and auto loans, mainly among customers with weak credit who live in markets that have been hurt by a decline in home prices.

If you read between the lines, the implication is quite obvious: the banks were well aware that people were using home equity appreciation to stay out of trouble with their credit cards. I’ve witnessed situations first-hand where an individual paid off their credit cards with a home equity loan and saw an immediate increase in their credit lines, even though the credit cards and home equity loan were from the same bank. Obviously, many of the banks were utilizing the same bad judgment with credit cards that they were with mortgages.

Late Loan Payments

The FDIC recently reported that late loan payments (of which mortgage payments are merely a portion) grew by 36.2% in a YoY basis, with residential mortgage loans that are 90 days delinquent growing by 12.6%. Loan provisions were also increased on YoY basis of around 75%. The key data point here is that late payments are rising on all types of consumer loans, indicating that consumers are difficulties servicing debt of all types.

Rising Auto Loan Defaults

In an earlier article, I noted that Capital One saw a nearly 60% YoY decrease in profits within its auto lending business. Back in July, MSN Money published an article detailing a surge in auto loan defaults and car repossessions:

One in three auto-loan borrowers have payments greater than $500 a month, according to consumer credit agency Experian, and 12% have been late at least once.

In a survey for the National Automotive Finance Association, BenchMark Consulting International said monthly repossessions by subprime lenders increased 15% last year.

[...]

For the first time in several years, prime lenders increased the number of loans extended to risky consumers. Those with FICO scores below 600 moved from 4% to 8% for used vehicles and 2% to 6% for new vehicles, BenchMark reported. "They're moving downscale, and they're also lending money to the higher-risk players," Cunningham said.

[…]

Subprime lenders also reached down the credit scale, with 54% of deals made to buyers considered a high or superhigh risk, those with FICO scores under 549, up from 34% in 2005. "All of these are kind of pointing to higher delinquencies and higher charge-offs," Cunningham said.

Consumers Living Above Their Means

Whether it’s auto loans, credit cards, mortgages, etc., a lot of the lending-related malaise is due to consumers who chose to live above their means or needed debt to finance day-to-day operations due to not being able to make ends meet. Right now, the brunt of this problem is concentrated within mortgage lending, but it stands to reason that it’s going to spread to credit cards, auto lending, and other types of lending rather soon. Wall Street ignored the oncoming mortgage crisis even though there were plenty of signs signaling it was coming, so will it ignore the oncoming consumer debt crisis as well?

Comments

[DU Only]

Great article! I agree a consumer credit crisis is next. After all, there are more layoffs every day. Those people are going to have to exist on their cards for a while, because there are just no jobs out there paying the same salary they were getting from the mortgage companies....

[AlanBrochstein]

Well put! Your scenario is exactly what I have been anticipating. U.S. Consumer Spending (as measured by the Personal Consumption Expenditure) hasn't gone negative year-over-year in quite some time on a real basis. The last time was 1991 and before that in the early 80s. The median for the past thirty years has been 3.4%, and we are currently at 2.8%. What I find interesting besides the long pause between consumer recessions is that each peak over the past thirty years has been lower: 7% at the end of 1983 (strong growth post-recession) and then almost 6% in 1998 and then 2000. Since the drops to about 1% in late 2001 and 2002, the year-over-year growth has stalled at just 4%.

To me, this says that despite having a fully employed economy and a huge infusion of spending power via the mechanism that you described (reloading credit card debt after tapping home equity), our mature economic expansion is tired. I think that the downside risks are tremendous. It also seems that money has been spent outside of "consumer spending" - stock market, real estate, etc. I have taken on the moniker Armageddon Alan for the next year or so!

[Markham]

I think many people are underestimate the impact overspending has on the economy; personally, I don't see how businesses that depend on consumer spending can grow over the next 3-5 years if consumers are forced to pull back live and within their means.

In my opinion, the American consumer no longer understands what "affordability&qu... means, it used to mean what you could reasonably finance with your income, now it means what you can finance with credit. At some point, you gotta pay the piper.

The economic implications of a forced return to common sense spending are mildly disturbing to say the least.

[Biggie G]

This makes perfect sense. Anyone who has been in the business any time at all understands that borrower's default on mortgages as a last resort - usually. It would seem to me that there should already be a mess, as borrowers would default on revolving and installment debt first - or at least simultaneously.

[emily x]

"The key data point here is that late payments are rising on all types of consumer loans, indicating that consumers are difficulties servicing debt of all types." -- Very interesting article. Personally, I think this problem goes back to the dot-com crash of 2000 and the post 9/11 recession of 2001/02. Many people who lost jobs in those years never regained their previous level of income. By some estimates, a significant percentage stayed unemployed -- becoming "consultants"... or otherwise scraping by. These people are not accounted for in the unemployment stats. Once the 28 weeks of UI run out, you drop off the ranks of the unemployed whether or not you've found work. I believe real unemployment in this country is higher than we think, and the "living beyond their means" that you mention, while true for some, for a lot of people is just paying for necessities on very little income.

[Paranurd]

Excellent points! And the job losses in IT and other areas continue. One IT company I am familiar with is in the process of being acquired in a private equity deal and before the acquisiton is final they have announced significant number of jobs will be outsourced abroad. We are becoming a two class society--the gap is widening and you are correct that a portion of the costly consumer debt overlad relates to purchasing necessities (real or perceived).

[Markham]

One of the consequences of "under-employment... is that when people go from one middle class rung to another (even within the upper MC ranks), they often try to maintain their lifestyles, which of course, leads to credit abuse.

Speaking of underemployment, around this time last year I was at an assignment in California sitting in a meeting with some upper-level IT managers. The questioned was asked: "How many of you are making as much as you were in 2001?"

No one raised their hand.

[Paranurd]

Consumers have fueled the U.S. economy for some time. What sector will step up to take the place of the tapped out consumer? Further, I wonder if many have stepped back and thought about Friedman's "The World is Flat" as a backdrop to the current situation? Will a debt laden U.S. be able to compete with China and India who turn out huge numbers of highly educated engineers and other professionals positioned to lead innovation? Will our children's work ethic match that of our Asian competitors? Its hard not to worry.

[AndreasStover]

Marc Faber recently mentioned in an interview that the sectors of the stock market bottom out around the same time, but peak out over a longer stretch of time.

It might not be too far fetched to believe that the credit cycle would follow the same pattern. After all people who need credit will try to obtain it another way, if one credit market tightens. They will thereby cause a yet loose market to expand further and eventually push up rates of default there too.

The most important credit data for investors is the default rate on corporate loans, which is still exceptionally low. However, according to the July data from the Federal Reserve Board's Senior Loan Officer Opinion Survey on Bank Lending Practices credit standards are slowly beginning to tighten on commercial and industrial loans.

Should we see a spike in this data, investors should probably be very careful where they put their money.

See: www.federalreserve.gov...

Andreas Stover
cyclesandtides.blogspo...

[tlc8386]

The consumer will just find other ways to spend shopping around their credit card debt or selling some of their toys they have bought. Once you are addicted to a nicer style of living it's very hard to go back. Luxury cars can now be leased is a prime example of this.

You don't have to own the lifestyle just look like you do! This is what we have done to the consumer!!