Friday, October 23, 2009

Consumer credit and deleveraging: who is wagging the dog?

Yes, everyone is talking about consumer deleveraging. It's a given. The US consumers are scared of job losses and foreclosures and they are using some of their income to pay down debt. The chart below shows total outstanding consumer credit that includes credit cards, student loans, and other non-real estate related debt. It's the standard number the Fed publishes routinely (G.19), and most analysts use it as an indication of "deleveraging". Many are predicting the consumer deleveraging has ways to go.

Source: FRB, Bloomberg

Of course everyone assumes that deleveraging for the US consumer is a matter of choice. Boomers just decided to pay down their credit cards and here we are. Rational financial planning is back.

But how much choice do consumers really have in their deleveraging decisions?

It seems the consumer behavior with respect to credit is driven more by what banks have been doing. That is the US consumers have deleveraged only to the extent that banks wanted them to. Banks in the US have a specific exposure target they want to maintain to consumer credit. It turns out the sweet spot is just over 7% of total assets. Banks have the consumer exactly where they want her - with just enough card debt to keep profits rolling and risk at acceptable levels. The chart below shows consumer credit as percentage of total assets since the beginning of 08. It's amazingly stable.

source: FRB

So this idea that the consumer has wised up and is willingly paying down credit card debt may be a myth. Banks have been aggressive in reducing credit card exposure as they shrink their own balance sheet. As banks stop their own deleveraging, they may choose to keep their consumer exposure at around 7%. At that point all this "consumer deleveraging" may grind to a halt. So when you see consumer credit stabilizing, (which may be quite soon) it's not necessarily an indication that everyone decided to go shopping again. It just may be that banks are done with their own deleveraging.
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