The Pain of Deleveraging Hits the Consumer

A very interesting note on consumer credit was published on by John C. Ogg as banks slowed down lending at a record pace in March.

“If you think that credit to consumers (and by consumers) was being cut, you will see that thought was an understatement. Consumer Credit for the month of March was just released and it is the largest percentage drop in almost two decades. The March consumer credit came in down $11.1 billion. Bloomberg had estimates of -$4 billion and Dow Jones had noted a -$3.5 billion drop. It looks like this is actually a record drop measured by dollar terms.

February’s consumer credit was revised to being down $8.1 billion from being down $7.5 billion originally…

You can decide on your own if this is banks still contracting their credit or whether it is consumers finally deciding to migrate toward a cash economy. Either way, keep in mind that this was March data and therefor was before much of the new more stable confidence and spending.” John C. Ogg 5/7/2009.

Essentially the experts were predicting a moderate pull back in consumer’s borrowing power, but the results were close to 300% of the estimates. The total consumer credit available is $2.55 trillion which is a decline of 5.2% from a year ago. Revolving credit available, such as credit cards, is declining faster (6.8% annually) than non-revolving, which makes sense. We have heard anecdotes here and there that credit lines are being reduced and in some cases credit card accounts are being shut down, and in many cases it is people with strong credit histories. There is no doubt that banks are getting more cautious about consumer credit, and for good reason as superstar analyst Meredith Whitney believes that consumer credit is the next shoe to drop. She is not alone in her theory, and that is something that banks could do without as they are still extremely vulnerable.

According to some quick calculations, with data taken from the Bureau of Economic Analysis, for the year 2008 consumers personal income minus income taxes otherwise known as disposable personal income was about $10.6 trillion. So, the average American with $2.55 trillion in consumer credit available was able to leverage up somewhere in the neighborhood of 24%. That is a conservative estimate because consumer credit has been clamped down thus far in 2009. That may not sound like a lot compared to investment banks having $30 invested for every $1 supporting it, but it still means that if so desired the average American could spend $1.24 for every $1 made.

The record decline in credit available is a necessary part of reigning in a financial system that allowed the U.S. economy to become over-leveraged. As any student of finance knows, leverage can magnify the good times, but it can also magnify the bad. This could potentially have an adverse effect on GDP in the coming quarter by restraining consumption, but I doubt it will have a huge impact. After all, it is healthier for our economy to have consumers that are able to pay for what they have than to have a default problem in the near future.

The Pain of Deleveraging Hits the Consumer

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