The Misleading Decline in Consumer Debt

Consumer debt has now fallen for 10 straight months, but the decline may be more indicative of charge-offs and defaults than it is of a move toward fiscal responsibility.
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) -- With all the talk of surging national debt, and how the government can resolve its budget deficit, it's worth looking at how Americans are handling their own personal debt.

It would appear that Americans are deleveraging, with outstanding consumer credit having declined in each of the past 10 months. It would also appear that they're being smart about it -- paying down the most expensive debt first.

Revolving debt, which is comprised mostly of high-interest credit card loans, stood at $874 billion in November, on a seasonally adjusted basis. That's down 9.3% over the past year, and 18.5% from the previous month, on an annualized basis. Less-expensive nonrevolving debt, such as auto and student loans, stood at $2.46 trillion, down 3.9% over the past year and 8.5% from October, on an annualized basis.

Part of that comes from responsible folks paying down credit-card bills and extinguishing other debt. But the decline doesn't all stem from loan repayments. In fact, there seems to be a close correlation with loan forgiveness in the form of banks writing off debt they assume will not be repaid, as well as bankruptcy filings and loan-workout programs.

For instance, several of the country's largest credit-card lenders reported a rise in charge-offs in November, after two months of declines, including

JPMorgan Chase

(JPM) - Get Report


Capital One

(COF) - Get Report

, and

Discover Financial Services

(DFS) - Get Report


Bank of America

(BAC) - Get Report

said its charge-off rate continued to slide for the third straight month, but as the credit-card lender with the highest default and delinquency rates, it may have been more aggressive in writing down bad loans earlier.

Broadly speaking, consumers' revolving debt declined at a slower pace in September and October, followed by November's accelerated drop.

At the same time, a startling number of Americans have been filing for bankruptcy -- more than 1.4 million in 2009, a 32% increase over the previous year, according to the National Bankruptcy Research Center. The numbers have topped 110,000 for the past 10 months, and while December usually has fewer filings, levels remained unseasonably high.

As credit-card lenders are admitting defeat and bankruptcy courts are granting forgiveness, mortgage lenders are granting forbearance.

More than 1 million homeowners have been offered home-loan modifications through the Obama administration's Home Affordable Modification Program (HAMP), and another 2.3 million are eligible. Outside of that program,

Fannie Mae


Freddie Mac

have been active in preventing foreclosure and keeping people in their homes, and the government has agreed to extend

unlimited support

for them to do so.

Lenders have also begun their own initiatives for borrowers who don't qualify for HAMP -- sometimes helping far more customers than within the program. For instance,

Wells Fargo

(WFC) - Get Report

, one of the country's largest mortgage servicers, said its own modifications through October exceeded HAMP modifications by a factor of 3.3. Bank of America's private modifications exceeded HAMP's by a factor of 1.4 through November.

As these realities about the average household balance sheet persist, politicians have been blasting the spendthrift nature of government bailouts and economic recovery measures. Conservatives and certain "blue-dog" Democrats have stoked fears about inflation, cast foreign holders of Treasury securities as villains who will assert influence over U.S. affairs and presented dire forecasts of where the current fiscal course may lead.

While the rhetoric is often grating, they may have a point.

National debt clocked in at $12.3 trillion at the end of 2009, and represented roughly 79% of gross domestic product. Fitch ratings estimates that it will rise to 89% this year, and 94% in 2011. Analyst Brian Coulton noted that reaching 100% "would be a serious concern from the perspective of the U.S. AAA rating."

A recent study by two academic researchers analyzed economic data for 44 countries over 200 years, and found that the 90% benchmark can be dangerous. Above 90%, the median economic growth rate falls by one percentage point, and average growth drops more drastically. In the U.S., debt levels over 90% of GDP also lead to "significantly elevated inflation," between 5% and 7%.

The study, by Carmen Reinhart of the University of Maryland, and Kenneth S. Rogoff of Harvard University, also found that for the five countries with "systemic financial crises" -- Iceland, Ireland, Spain, the United Kingdom and the United States -- average debt levels are up by about 75%.

"The sharp run-up in public sector debt will likely prove one of the most enduring legacies of the 2007-2009 financial crises in the United States and elsewhere," the authors write.

What does all of this mean for the U.S. balance sheet? Essentially, our finances are wrecked, and the average household doesn't seem to have learned much from the financial crisis.


Written by Lauren Tara LaCapra in New York