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America's Credit Score Doesn't Add Up
The Accepted Wisdom
It is generally believed that Americans are deleveraging. This deleveraging represents an economic headwind that is holding back consumption. Politicians opine that the Bush Tax Cuts should be extended to prevent a greater slowdown. Chairman Bernanke opines that more monetary stimulus is needed.
Graphs of outstanding debt, all seem to confirm that the peak in private debt was passed in 2008.
More money from a fiscal or monetary source, depending on the agenda, is requested. The deleveraging mantra has become a convenient excuse to get more stimulus from either the Treasury or the Federal Reserve.
A cursory look at the St. Louis Fed's data on total consumer debt however, suggests that debt is actually increasing again. In fact, the total amount of outstanding consumer debt is back at its old Bubble peak.
How can deleveraging be occurring, when total consumer debt is increasing?
Deleveraging is not occurring in some of the most risky sectors. The banks wrote off some debts after the bubble collapsed; and put others on the non-performing list. As an example, $213 billion dollars of Credit Card debt was written off in 2010; from the peak level of $ 1 Trillion in 2008. Recent Fed data showed that Credit Card Debt was at $ 850 billion. This means that $63 billion of new Credit Card debt has been created since then. But this new debt was not just used to finance consumption. Americans now pay their utility and tax bills with their credit cards. Subsistence re-leveraging has become prevalent. A curious form of income redistribution is disguised in this data. The $213 billion write off was taken by the taxpayer as part of the banking bailout. The new $63 billion of Credit Card debt then paid interest to the taxpayer as the principal shareholder in the banks. Taxpayers therefore subsidized the bankers' losses; and then were rewarded by being able to lend back to themselves via their credit cards. Had they not bailed out the banks, the money would have stayed in their pockets; and they would not have needed to use the credit card emergency funding line.
Turning to the auto sector; the stimulus, called Cash for Clunkers, caused the first spike in auto sales. However, since then new and used car purchases have been made with non-revolving auto loans. During the first quarter of 2012, auto loans outstanding totalled $52.5 billion; almost 50% higher than in 2009. Since 2009, the economy has grown 12% and auto loans have grown 33%. The average size of new auto loans also grew by $589 to $25,995; and $411 to $17,050 for used autos. The terms of payment were also extended; by an average of one month to a level of 64 months on new and 59 months on used autos. In fact, a new category of auto loan called "Deep Subprime" was created; for people with Vantage scores below 600. Deep Subprime has a 10.7% market share; and Subprime has a 45% market share of all auto loans. Two thirds of all auto sales are for used autos and one third is for new autos.Subrprime auto borrowing increased from 52.7% to 54.6% over the first quarter. The average loan-to-value ratio on new car loans was 109.55% and 126.62% old cars. Approximately 77% of Subprime auto loans have a maturity greater than five years.
It is logical to conclude that Americans are using Subprime auto loans as a source of cash to be used on more than just car purchases. The car has become collateral rather than a mode of transport.
The next culprit to find the source of increased consumer credit is student loans. As a policy strategy, to mask the true level of unemployment, the Federal Government holds $500 billion of student loan debt. This has risen by $100 billion since 2008.
If one adds up the credit card loans, auto loans and student loans one can see where the increase in total outstanding debt has come from. The expansion in credit has been for emergency credit card use, subprime auto loans and the unemployed renamed as students. The asset quality is poor and the repayment risk is high.
Well capitalised borrowers have deleveraged and reduced their borrowing costs; through refinancing at low interest rates during the Fed's extended low interest rate period. Poor credits have increased their indebtedness and inability to repay. Since banks have also tightened lending standards, the well capitalised borrower has achieved lower financing rates; and the indebted borrower has been hit with even higher rates. The Fed has tried to ease the pain, for weaker credit borrowers, by applying Operation Twist to force lending rates lower. The benefits of the Twist have accrued to the stronger and not the weaker credits though; which is why a new round of monetary stimulus is now contemplated.