Going Debt Crazy: What the Financial Crisis Did to Credit in the U.S.

Debt

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Credit makes the world go around — at least, it fuels the United States economy, which for the time being is the largest in the world. Consumer crediting outstanding increased at a seasonally adjusted annual rate of 7.3 percent in December, according to a preliminary calculation by the Federal Reserve. Total revolving credit outstanding, largely tied up in credit card debt, increased by $5 billion, or about 0.6 percent, to $861.9 billion.

Credit card debt has a mixed reputation as far as economics is concerned. On the one hand, increases in credit card use and a reasonable accumulation of debt means that people are spending money and could signal improved consumer confidence. Given that nearly 70 percent of the U.S. economy is driven by consumer spending, both of these are generally economic boons, and credit cards play an important role in servicing the financial needs of consumers.

On the other hand, the irresponsible accumulation of debt can be destructive to personal finances, and from there, the damage can aggregate up to the economy at large. If a consumer abuses their credit facility and spends beyond their means to repay, they will bear the burden of high interest and be forced to dedicate future income to the service of the debt. This is good for the economy the moment they spend the money, but a drag in the long-term as they work down the debt.

We’ve run out of hands, but a third possibility is that people are turning to credit cards out of necessity. Large, unexpected costs such as medical bills, vehicle repairs, and winter heating bills (thanks a bunch, polar vortex) are often put to credit. In the event of unexpected unemployment, some people are forced to turn to credit cards to cover the cost of living.

This makes the credit data release by the Fed difficult to understand without additional context. We need to know which hand consumers are using their credit cards with. In 2013, total credit increased 6.2 percent, revolving credit increased 1.9 percent, and nonrevolving credit (things like car and student loans) increased 8.7 percent — does this signal a healthy increase in consumer confidence or does it reflect economic hardship or financial irresponsibility?

The answer is some opaque cocktail of all of the above, but additional data can help shed light on the recipe. For some context, take a look at the amount of total revolving and non-revolving credit outstanding since the late-2000s financial crisis. One component of the crisis was tied to credit, and you can see that revolving credit outstanding is down dramatically from its peak in 2008, and post-crisis growth is markedly slower. However, non-revolving credit outstanding has increased dramatically over the past few years.

Credit Outstanding

This suggests that, in general, people are taking on less credit card debt but more fixed-payment loans. A lot of this growth in non-revolving credit has come in the form of student loans.

The Federal Reserve Bank of New York reported in March 2012 that there were 38.8 million student borrowers in the United States carrying an average debt burden of $24,803. Total student debt outstanding is over $1 trillion, more than the total level of credit card debt outstanding, and increasing at a much faster rate. Total student debt outstanding increased 11 percent in 2013, leaving borrowers with a debt burden dwarfed only by those with mortgages. NerdWallet estimates average student loan debt of $32,258 and average mortgage debt of $149,925 for 2013.

There are a lot of theories for why student debt has increased so dramatically over the past few years, but the ultimate culprit is likely the financial crisis. Millions of people who found themselves out of work and facing a terrible job market decided to hunker down, take out loans, and go back to school, hoping to weather the storm and emerge more employable than before. Many parents became unable to help pay for college, forcing high school graduates to assume more debt. All the while, the cost of education soared as students flooded the gates.

Some general themes of the student loan issue apply to other forms of non-revolving debt like car loans, but the message is similar: it’s hard, if not downright impossible, to avoid taking out a loan for certain things. For the average person, going to college, buying a car, or buying a home means taking out a loan. In these cases, assuming you are intelligent about how much money you can feasibly borrow and how you will repay it, this is fine — good, in fact. Student, car, and home loans are essential to the success of their respective industries, and the economy relies on people using nonrevolving credit responsibly.

But, as mentioned, the roll of credit cards is a little more dubious. According to NerdWallet, average credit card debt has fallen nearly 18 percent from its pre-crisis high of $8,740 per household in the fourth-quarter of 2007 to $7,168 per household in the fourth-quarter of 2012.

However, NerdWallet is quick to point out that median credit card debt is just $3,300, less than half the average debt level. This discrepancy is key to understanding the nature of the slow expansion of revolving credit over the past few years.

The large discrepancy between mean and median credit card debt suggests that a relatively small number of highly indebted households are weighing on the overall average. According to NerdWallet, 46.7 percent of households have a credit card balance, and of those households that are indebted average credit card debt is estimated at $15,630. Or, in other words, the credit health of U.S. households is highly polarized.

This was evident in the wake of the financial crisis when financial institutions began writing off huge amounts of credit card debt they assumed was noncollectable. The charge-off rate broke 10 percent in the third-quarter of 2009 and remained above 10 percent until the second-quarter of 2010. The rate has since declined to a normal level, but billions in debt has been written off. More than improving personal finances and increased responsibility on the part of consumers, these write offs attributed for the massive decline in total debt outstanding since the peak of the financial crisis.

While these losses hurt at the time, a few years after the fact the credit environment looks about as healthy as anyone could hope for. One way to measure whether consumers are borrowing within their means is to look at debt service payments as a percent of disposable personal income (personal income that is left over after taxes). After peaking at nearly 13.5 percent in the fourth-quarter of 2013, this rate plummeted in the wake of the crises and currently sits below 10 percent, the lowest since at least 1980.

Debt Service

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