Wall Street analysts sported some serious egg on their faces last when they predicted that consumer credit would be down by $4 billion for the month of July. Nice try, as the number actually dropped by a whopping $21.6 billion, according to the Federal Reserve, which regularly tracks consumer debt trends.

Aside from lousy economic projections, there are bigger issues in play. Specifically, why the drastic reduction in consumer credit?  And what does it mean to creditors and consumers?

Consumer credit is just another way to classify consumer borrowing habits. With the July number, that means those habits are trending downward, as Americans cut their borrowing by historic levels. Not since 1943, when the government actually began tracking consumer credit trends, have Americans cut their borrowing by so much.

And make no mistake, Americans cut back debt across the board.  According to the Federal Reserve’s data, consumer demand for what the Fed calls “non-revolving credit” declined by $15.4 billion. In Main Street terms, that means Americans are cutting back on things like family vacations, new cars, and even spending on college and adult higher education classes. "Revolving debt," for things like credit cards, is also way down, by $6.1 billion in July (following a 6.4% decline in June).

That begs the question: are consumers cutting back on borrowing because they are becoming better stewards over their spending habits? Or is it a matter of banks and other creditors tightening the credit screws, thus boxing out many consumers from borrowing money?

Actually, it’s a combination of both sides of the supply and demand coin. The Chicago School of Business says it’s seeing declines in loan demands from consumers, but it’s also a big cutback in the amount of credit that financial institutions are making available.
So while consumers are cutting back on borrowing, their hand is being somewhat forced by banks and other lenders who are making it tougher for consumers to get credit – at least on decent terms.

Other reasons include onerous credit card rates and restrictions. Credit card companies have been busy cutting credit limits in 2009. According to FICO, credit card companies cut limits for 58 million card holders in a 12-month period between April, 2008 and April, 2009. Plus, according to the Pew Safe Credit Cards Project, the average U.S. consumer credit card interest rate rose from 9.99% in December, 2008, to 11.99% in July, 2009. Pew also says that card company profits on credit card debt rose 46% over the same time period.

Debt is also down because over six million Americans have lost their jobs since 2006. With that many consumers on the sidelines, hunkering down financially until they find new jobs, demand for debt will be softer than usual.

Overall, the massive decline in U.S. consumer debt shows no sign of declining. Since banks can borrow money from Uncle Sam on the cheap – with interest rates of 0.5% or 1% fairly common on public/private loan deals – creditors are in no rush to lighten borrowing standards. Bottom line: banks just don’t need the money.

On the other side of the ledger, Americans seem to be sincere about mending their free-spending ways. Until consumers get their debt loads down to manageable levels, and until the economy promises more jobs and better wages, expect this miserly mindset to maintain its hold over edgy consumers.

The end result? On the downside, less spending, more debt reduction, and less of a boost to U.S, businesses, and the economy in general. On the upside, however, lower debt means more and more Americans are stabilizing their financial futures.

—For a comprehensive credit report, visit the BankingMyWay.com Credit Center.