More Trouble Ahead

More Trouble Ahead

From the Washington Post:

“Consumers are increasingly unable to pay off their credit cards, forcing banks to hoard cash to protect against future losses and lend to fewer people, according to reports yesterday from several of the nation’s largest banks.

These financial disclosures showed a spike in credit card loans going bad, putting further pressure on already-stressed balance sheets. J.P. Morgan Chase said the number of credit card loans in default rose 45 percent in the third quarter from the comparable period a year ago and predicted that default rates would sharply accelerate through 2009, with 7 percent of credit card loans going bad. (…)

The deterioration in consumer credit, the latest downturn to whack Americans after the housing slump and mortgage meltdown, threatens one of the linchpins of the U.S. economy. Over the past 10 years, credit card debt has gone up 75 percent as Americans’ real wages and savings rate have stayed flat. That means Americans have been spending beyond their means — and fueling economic growth with borrowed money.

Now, the housing crash, financial downturn and contracting economy have made it more difficult for Americans to settle their bills, setting off a downward spiral. As people fail to pay off their credit card bills and other loans, banks must put away money to cover expected losses. So banks lend less. Americans who tended to rely on loans to fuel their spending must cut back, readjusting their spending habits to conform with what they earn.

“Given that the savings rate has been minuscule, there’s no reserves in the tank for the consumer to tap his savings to support his spending,” said Scott Valentin, a financial services analyst at Arlington investment bank Friedman Billings Ramsey. But consumers have been driving about two-thirds of the U.S. economy.

Overall, the rate of credit card loans going bad increased 54 percent in the second quarter of 2008 from the same period in 2007, according to Federal Reserve data, the latest available.

A report this week from Innovest, a research firm, said banks and other credit card lenders could record nearly $100 billion in losses because of bad loans through the end of next year. Innovest said financial firms could be reaching a “tipping point” at which years of growth in credit card debt starts to decline.”

There are several problems here. The first is the possibility that banks will have to write off even more bad debt. Americans owe about $950 billion worth of credit card debt, and, as with mortgages, credit card debt has been securitized. The second is that banks might hoard cash if they think they will have to write down bad debts, at a time when credit is already very tight. But the third is that, as the Post notes, consumer spending drives a lot of our economy. But there’s a problem:

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Wages have been flat for the better part of a decade. We made up for that fact by borrowing, both against our houses and on credit cards. Since virtually every form of credit seems to have dried up, and a large jump in people’s wages doesn’t seem to be in the offing, it’s hard to see how consumer spending will not take a very serious hit. And if it does, the economy will suffer enormously.