The Fed published yesterday its monthly consumer credit report for May 2010. Total consumer credit outstanding fell by $9.1 billion in the month, after a drop in the previous month of $14.9 billion, revised from a previously estimated gain of $1.0 billion (we are awaiting the next Fed paper entitled “Counting is Hard. Don’t Let Bloggers Tell You Otherwise.”) The total drawdown from the peak in 2008 has been roughly $167 billion, a drop of 6.5% from a high of $2.58 trillion.
Consumer credit is made up of two components: revolving and non-revolving. Revolving credit consists of credit cards and other unsecured lines of credit that can fluctuate up or down from month to month. Non-revolving credit is made up of loans used to purchase automobiles, durable goods, and other personal expenditures that get paid down in more or less a straight line. The Fed’s consumer credit data exclude mortgage debt (loans, home equity lines of credit, etc). As the graph below shows, the bulk of consumer deleveraging has thus far been shouldered by revolving credit.
It makes sense that in times of stress, consumers would first choose to pay down higher interest borrowing such as credit cards, but in practice this is a unique event. The relatively short history of unsecured revolving consumer credit is an interesting one, with growth from $0 to nearly $1 trillion in roughly 40 years, a 17.5% annualized growth rate. It’s no wonder there is such durable faith in the ability of the American consumer to spend. However, last year marked the first year-over-year decline in this data series.
The mid-to-late 1990s saw impressive growth in consumer non-mortgage credit, as you can see in the first chart. This growth was not only in absolute dollars, but more importantly in terms of the income that must go to service that debt. The chart below looks at total consumer credit outstanding as a percentage of personal disposable income: the non-mortgage debt-to-income (DTI) ratio.
Who is to say what the “correct” consumer DTI ratio should be? It’s rational to think that lower interest rates equate to a higher DTI, because the same level of debt service can fund higher levels of leverage, and interest rates have been falling steadily since the early 1980s. However, a reversion to a DTI of 0.20 would point to a further drop in consumer credit of about $165 billion (i.e. holding income constant, we’re about halfway through the deleveraging). Again, who knows if a 0.20 ratio is the sweet spot. Holding disposable personal income where it stands today, each 0.02 drop in the ratio equates to another $225 billion decline in consumer credit outstanding. Growing incomes would be a far less painful way to deleverage.
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