Saturday, August 15, 2009

Credit cards cause the recent drop in consumer credit

The US consumer credit continues to fall, showing a reduction for a fifth straight month. From CNN:
Total consumer borrowing sank a seasonally adjusted $10.3 billion, or 4.9%, to $2.503 trillion, according to the Federal Reserve. The report measures how much debt consumers have outstanding.

The chart below shows the total consumer credit (excluding real estate based credit) for recent years.

Source: the Fed

What's interesting is that consumer credit only started coming off it's peak in early 2009. How is that possible if the recession has begun in 2007? Many point to this as some sort of sign that the consumer has finally started to voluntarily deleverage. But let's look under the hood of this consumer credit measure from the Fed. Who is actually providing this credit?

This chart shows the breakdown of major sources of consumer credit. Contrary to popular belief it's not all coming from banks.

Other key sources are finance companies (like Ford Motor Credit, etc.) and the securitization markets. To some extent it's also the credit unions and of course the US government. Let's examine the three largest sources first. The chart below shows that the declines in consumer credit actually started at different times, depending on the source.

Consumer credit from the securitization markets started its decline in 2007 with the collapse of the commercial paper markets (much of the securitization market was financed via commercial paper). Note that last month, the consumer credit from the securitization markets actually showed an increase. That is mostly driven by TALF. However this market is no longer contributing to the overall decline in consumer credit.

Finance companies started tightening credit around the time of Lehman collapse because it became increasingly difficult for them to raise funds in the capital markets. Unlike banks, finance companies do not have deposits as a source of funds. But recently the declines have stabilized, in part due to the stability in the corporate credit markets.

The largest source of the decline in consumer credit, particularly recently, have been banks, as they started tightening credit card availability in 09. This decline is continuing.

People often think banks make decisions and act quickly in response to the markets. In fact they usually don't, particularly in the consumer space. Banks continued to grow credit card financing all the way through the end of 08. It took a while for their internal policy machine to kick in. Remember those credit card offers from Capital One? They kept coming in, even as the financial system was melting down.

What about the other components of consumer credit? It turns out that credit unions continued to lend without much interruption, while the government and Sallie Mae actually increased lending (particularly student loans.)

So why are banks suddenly cutting up plastic? Part of it is due the rapid rise in credit card default rates. Part of it is in preparation for the new consumer protection laws from the Obama administration. From
Under the new rules, credit card companies are hiking interest rates into the double digits, slashing limits, closing accounts, offering far fewer teaser rates, hiking balance transfer and cash advance fees and shifting customers to variable rates. Changes have been building throughout the year — part due to the recession and part to beat new consumer protections going into effect next year.

So under the hood, the most recent declines in consumer credit are primarily driven by the changing landscape in credit card offerings. Ironically this is, at least in part, an unintended consequence of the recent government action on consumer protection.

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