During the Financial Crisis, consumers deleveraged by walking away from their debts. And now, with 20 million people still claiming unemployment insurance?
By Wolf Richter. This is the transcript of my podcast last Sunday, THE WOLF STREET REPORT.
During the Financial Crisis, credit card debt and home mortgages blew up spectacularly. When it was all said and done, about three years later, total credit card debt and home mortgage debt had plunged, not because consumers had paid them off but because consumers had defaulted on them and had walked away from their debts.
Now, at this stage of the Pandemic, 9 million people, according to the Bureau of Labor Statistics, and 20 million people, according to unemployment insurance claims, have lost their jobs. With these kinds of numbers, you’d expect consumer credit to blow up even more spectacularly than it had during the Financial Crisis. But the opposite happened.
For extra credit and not visible in the original podcast: a WOLF STREET reader (yup, “Rudolf”) took this photo to commemorate 2020:
Now, with credit cards, the banks make money in two ways. Many people use their credit card as a payment method, but they pay them off every month to avoid having to pay interest to the bank. With these people, the bank makes money because it gets paid a fee from the merchant for each purchase.
Other people use their credit cards not only as a payment method, but to borrow, and they pay interest on their credit card balances. With them, the bank makes money twice: first on the fee at purchase, then the interest on the credit card balance.
That interest can be very high. 25% is not uncommon. Sure, someone with excellent credit and plenty of money might be able to borrow at 8% on their credit cards, but they don’t need to borrow on their credit cards. They can borrow at lower rates in other ways.
It’s the people who have to borrow to meet their everyday expenses and who cannot pay off their balances, but can only make payments on their balances, who pay these high interest rates.
Credit card interest hasn’t really budged, despite the near-zero-interest rate policy the Fed has been pursuing, and despite its interest rate repression through asset purchases that have brought down long-term interest rates.
Apple can borrow for three years at something like 0.4%, and it can borrow for 15 years at something like 2.4%, based on its current bond yields.
But the average interest rate on credit card balances that are accruing interest – so these are people who are not paying off their credit cards every month but are paying interest on their balances – was over 16%, according the Federal Reserve data. This is higher than that average was in any of the prior years going back to the 1990s.
So the interest rate repression by the Fed doesn’t apply to credit cards. And for the banks in this zero-interest rate environment, credit card lending is a huge profit center with enormous profit margins.
For the Federal Reserve, which is responsible for the banks and regulates the banks, and whose 12 regional Federal Reserve Banks are owned by the banks in their districts, those high profit margins on credit cards are sacred. They fatten bank profits, and that’s what the Fed wants, especially during times when lower interest rates make other types of lending less profitable.
But here’s the thing – and it frazzles the Fed, and it has expressed its concerns over this already.
Credit card balances have plunged by over 10% from a year earlier, the largest year-over-year decline going back to the early days of credit cards. Balances are now back where they’d first been in August 2007, despite population growth and inflation.
During the Financial Crisis, credit card balances also declined, but they took a lot more time to do so. It took nearly three years from peak to trough, and balances fell because banks wrote off the balances they couldn’t collect. Credit card charge-off rates by banks were in the double-digits for an entire year starting in Q3 2009.
Credit card debt is unsecured, and lenders cannot repossess or foreclose on anything. They have to go to court and get a judgment and then execute on that judgment. But if the defaulters have lost their jobs and their homes by the millions, and they don’t have anything anymore, even obtaining a judgment doesn’t necessarily allow the bank to collect anything. So banks sold this debt for cents on the dollar to collection agencies, and the defaulted credit card balance disappeared from their books.
In other words, consumers deleveraged by walking away.
But during the Pandemic, delinquency rates have dropped for two quarters in a row, and are now near historic lows, and charge-off rates too have dropped and are also low.
So consumers used their stimulus money and their extra unemployment benefits to cure their delinquencies and pay down their credit cards.
That’s a real problem with the Fed, because the interest and late fees from credit card balances are a huge profit center for the banks.
And credit card balances also dropped because consumers spent less on services such as hotel and airline bookings, cruises, restaurants, and many other services where credit cards are heavily used. And that’s a problem with the Fed because it wants consumers to crank up the economy by spending money they don’t have, and that’s what credit cards are for.
Consumers have also lost interest in applying for new credit cards. According to the Federal Reserve “Credit Access Survey,” which is released three times a year, with the latest coming out just before Christmas, the number of people who said that they’d applied for a credit card over the past 12 months plunged by nearly half from the Good Times, to the lowest rate in the data going back to 2013.
So not only are consumers paying down their credit cards at a historic clip, they’re also cutting back on applying for new credit cards.
Let’s face it, we’re called “consumers” because it’s our job to consume. It’s not our job to be happy and fulfilled because that doesn’t do the banks and the stock market and the economy any good.
Our job is to spend money, and if we don’t have enough money to spend because we don’t get paid enough, we need to borrow this money and then spend it. Being reduced to “consumers” is our fate.
But if we don’t do our jobs and consume enough, the US consumer-based economy will grind down, and the global economy that supplies American consumers all this stuff will grind down, and all heck will break loose, globally. Everyone is counting on us “consumers.”
That’s why the fact that consumers are cutting back on credit-card borrowing frazzles the Fed; it stifles consumption; and the sky-high interest rates in a near-zero interest rate environment is where banks make out like bandits, while those consumers who can least afford it are paying out of their nose for these bank profits.
On the other hand, the Fed is happy with its handiwork on mortgages – though the bottom of the market is threatening to fall out, held in place only by forbearance programs and foreclosure bans.
In many parts of the country, there has been a veritable land rush. According to the National Association of Realtors, sales in November across the country were up nearly 26% from a year ago, back to levels not seen since 2005 and 2006, just before the housing bust. And the median price of existing homes jumped by 15% year-over-year. These would be huge numbers during boom times. But this is a pandemic when between 9 million and 20 million people have lost their work.
But then there is the other side of the housing market: 5.5% of all mortgages are in forbearance, according to the Mortgage Bankers Association. That’s 2.7 million mortgages where homeowners are currently in a deal with their lenders that allows them to skip making mortgage payments.
Some mortgages have exited forbearance in some way, either by the house being sold and the mortgage getting paid off, or by the mortgage being modified with extended terms and lower payments, or in some other way. But new mortgages are still entering the forbearance programs, and since early November, there has been no improvement in the number of mortgages in forbearance.
Many of the mortgages that are now in forbearance programs were delinquent before they entered into forbearance, and by being in forbearance, they’re no longer considered delinquent, but the problem remains. It’s just a form of extend and pretend.
Then there’s the Federal Housing Administration, the FHA, which insures mortgages with low down payments extended to homebuyers with lower credit scores, including subprime credit scores. Down payments can be as low as 3%. The FHA currently insures about 8 million mortgages.
A record 17.5% of those mortgages are now in some stage of delinquency. This includes mortgages that were delinquent before they entered into forbearance and are still delinquent.
And nearly 12% of the FHA-insured mortgages are seriously delinquent – meaning over 90 days delinquent.
In some metros, the delinquency rates are far higher. In the Atlanta metro, 21% of the FHA mortgages are delinquent. In the metros of Houston, Chicago, and Washington DC, 22% are delinquent. In the Dallas, San Antonio, and Orlando metros, 19% are delinquent.
These delinquencies can mostly be cured by selling the home, thanks to the surging home prices. But in each of those markets, there are tens of thousands of delinquent FHA mortgages, and if they are to be cured by putting the homes on the market and selling them, the flood of new inventory and the nature of forced sales would put enormous downward pressure on home prices in those markets, and the efforts to cure those delinquent mortgages by selling the homes would set off renewed fireworks.
This is the other side of the housing market: Widespread problems with delinquent mortgages because 9-20 million people have lost their jobs. Those homeowners await a day of reckoning when forbearance and foreclosure bans end.
So we find ourselves in the weirdest economy ever. Part of the economy is rocking and rolling, such as everything having to do with ecommerce and Chinese imports, pushed up by a sudden switch of consumption from services to stuff, fired up by federal stimulus money of all kinds.
Stocks and bonds and home prices are sky-high, fired up by nearly free money from the Fed for those that have access to it, and by the Fed’s efforts to inflate asset prices beyond recognition to enrich the asset holders, and to enrich the biggest asset holders the most, and by the Fed’s effort to create the greatest debt boom ever.
And there are the broad national and local strategies of extend-and-pretend where delinquent mortgages are brushed under the rug of forbearance programs, and where renters are protected by eviction bans.
Part of the economy is in deep trouble, and millions of people are still out of a job, and about 800,000 people are getting laid off every week and are filing initial unemployment claims. These are huge terrible numbers. And consumption by regular people is still down from a year ago because people have cut way back on buying services, and the surge in purchases of goods hasn’t made up for it.
But the good thing is that people are paying down their credit cards. No one should borrow at double-digit rates during the Fed’s interest rate repression. To heck with the banks’ profit margins. $10,000 in credit card debt may cost that person $2,000 or even $3,000 in interest per year. That’s money down the drain of bank profits. If the borrower is falling behind, massive late fees begin accruing in addition to the interest, and the total owed the bank just jumps.
There are a lot of services and goods that people could buy with that money, and that would help the real economy a lot more than surrendering that money to the banks in interest and late fees to fatten up the bank’s profit margins.
And it would be a good thing if consumers stuck to it and continued paying down their credit cards that carry this usurious interest rate in a zero-interest rate environment – and to heck with the Fed’s wishes.
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