American Consumer Debt Trend Is Still Troublesome

NEW YORK (BestCredit.net) -- Since 2008, the U.S. economy has shown relatively consistent signs of improvement. The stock market has recovered all of its pre-recession losses, the national unemployment rate is ready to push back below 7.0% and manufacturing productivity has risen to multi-year highs.

However, this progress has not entirely filtered into all sections of the economy. Personal debt levels remain elevated from the broader historical perspective, and this is discouraging in terms of overall growth prospects as we move into next year.

In addition, the Federal Reserve has committed to start reducing its quantitative easing stimulus programs. At its December meeting, the Fed decided to taper its stimulus purchases by $10 billion each month. It is now clear that the Fed's historic stimulus programs should not be viewed as a long term support mechanism.

Average Debt Levels Show Little Progress

This essentially means that it will become increasingly important for both to more closely monitor consumer behavior in terms of debt levels at the individual and household levels. Recent studies show that consumer debt in America reached $11.3 trillion, which an improvement of less than 1% relative to last year's numbers.

In credit cards, the average consumer debt for households is now seen above $7,200 but this number is artificially skewed by lower income households with larger than normal debt-to-income ratios. When looking at highly indebted households by themselves, the average debt level spikes much higher (to $15,200). These households are especially vulnerable to negative credit events (such as major defaults or even bankruptcies).

Credit defaults and bankruptcies create a significant drag on the economy, as ultimately the lending companies themselves that are forced to foot the bill. This weighs on projections for earnings growth and makes it difficult for the stock market to generate sustainable rallies.

But the negatives extend beyond these areas. When households and individuals are forced into default conditions or bankruptcy, those borrowers are then unable to establish strong credit histories and make large purchases (in areas like housing or automobiles, for example). When consumers are unable to make the real purchases that drive the economy, overall growth rates suffer. This is likely to be true now especially, given the fact that there will not be as much added monetary stimulus injected at the Fed.

Trends in Debt Allocation

In order to begin reversing these trends, we first have to look at the places in which this debt has been accumulated. According to this series of infographics, the main trends can be found in four central areas: Mortgages, credit card debt, automobile purchases and student loans.

Not surprisingly, the major portion of this total can be found in the mortgage space, with more than two-thirds of the total household debt ($8.7 trillion) centered in home loans. And while this figure might sound alarming to some, mortgage debt should actually be viewed as "healthy debt" that allows the American consumer to build net worth and a more solid financial base.

Since mortgage debt is a long term commitment, the simple fact that a household is able to accrue debt in this area means that there is a stable financial footing and that the household is consistently able to meet its monthly payment obligations. Debt in major automobile purchases has some of the same characteristics, but to a lesser extent. The main point here is that debt associated with major purchases is much less of a concern when we look at the bigger picture. If anything, this type of debt suggests the ability to make the key purchases necessary to drive overall growth and keep the economy running in a normal fashion.

The real concern lies in debt in the other major areas. Here, we are talking about the long term trends in consumer credit card debt and in student loans.

By its very nature, consumer credit card debt is destructive in nature when revolving balances are held. This is the case for a few different reasons. First, credit card debt tends to be associated with much higher interest rates when compared to more stable debt, like those seen with traditional mortgage agreements. This creates debt burdens for consumers that are much more substantial when balances are not repaid in full each month.

When debt accumulates in this area, it also implies that the consumer is not able to repay even smaller debt obligations and is more likely to experience defaults or bankruptcy in the future.

Consumer credit card debt is now coming in above $856 billion, which will become more troublesome if we start to see marked increases in revolving balances and missed payments. For these reasons, it is important to always pay more than the minimum balance as this is the best way to avoid the predatory lending practices that are seen in many credit card agreements. This is especially true for card agreements that are directed at the sub-prime consumer base, as these agreements are almost always accompanied by interest rates at significantly higher levels.

Student Loan Defaults: Potential for Long-Term Concerns

The next important area to watch can be found in trends related to student loan debt, as there have been massive increases in this area in the last few years. On a yearly basis, the latest official figures show that total student loans have risen above $1 trillion. This is an increase of 12.3% from the previous year as more students have opted to avoid entrance in a weaker jobs market, choosing instead to invest in higher education. But while many will argue that student loan debt falls into the "healthy debt" category, there is some cause for concern as well. In particular, this is true in cases where the overall debt levels fall out of proportion with the expected earnings in careers associated with a student's chosen degree.

Of course, hiring rates and long term career prospects for those with a college degree far outweighs those with high school diplomas, so it does make sense to look at student loans as a viable option when pursuing an advanced degree.

Recent economic data show that monthly hiring numbers have improved far beyond the original analyst expectations in the financial markets. It will be important for these trends to continue in order for new graduates to keep a lid on their student loan levels. There are protective measures in place for students to avoid defaults in their earliest stages after graduation (with measures like deferment periods and subsidized interest rates).

In any case, the next few years will prove critical as we will need to see some slowing in the annual accumulation rates for student loan increases. This is likely to be the case as the labor market continues to show improvement. Confirmation will be important, however, in order to assess the true performance in these trends and this will be a key area to place the focus as the economy continues to progress in 2014.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

Sam Kikla is the founder of BestCredit.net, which offers the latest information in consumer trends, debt management and labor markets as they relate to the broader market environment. Focus is placed on investment decisions that are affected by consumer trends, and credit markets are addressed from the long-term perspective, with most of the attention paid to macro events influencing multi-year market positions.

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