Central Banks and Your Credit Cards

In recent days, the mainstream media has been increasing its coverage of the horrors of over-indebted consumers as noted in my posting found here where the Bank of Canada's Mark Carney gets a bit testy about the amount of debt his fellow Canadians are amassing.  I found this speech given by Federal Reserve Governor Elizabeth A. Duke at the Federal Reserve Bank of Philadelphia Payment Cards Centre Conference (sounds like an edge-of-the-seat gathering to me) on December 2nd, 2010.

First, let's put the number of credit cards in circulation in the United States into perspective.  From the Visa website, the company states that they had 772 million credit cards in circulation (274 million in the United States) and 1065 million debit cards (402 million in the United States).  Between the 2 cards, Visa completed 3.203 billion transactions in the 3 months ended September 30th, 2010.  From the MasterCard website, the company states that they have issued a total of 1.6 billion credit and debit cards.  In the third quarter ending September 30th 2010, they had processed 5.8 billion transactions.  According to statistics on the CreditCards.com website, in a survey completed in February 2010, 29 percent of respondents reported that they do not have a credit card.  This was a 10 percent jump from the number of cardless Americans in June 2009.  The average American (under the age of 35 years of age) get their first credit card at the age of 20.8 years.  Should you have time to peruse this website, it is a fountain of very interesting information.

Back to Governor Duke.  I'll take a few excerpts from her speech and comment as appropriate.  In the first section of the speech, Governor Duke discusses the recent changes in consumer credit:

"During the recent financial crisis, the Federal Reserve and other policymakers throughout the government took unprecedented actions to mitigate the fallout from severely distressed market conditions and support the flow of credit to consumers and businesses. Nonetheless, the level of credit outstanding for households has been very slow to rebound and remains lower than it was at the onset of the crisis. The reasons for the slow rebound are, without a doubt, complex and multidimensional. Still, it is worthwhile to examine the data and try to understand why credit growth is not more robust.

For this forum, I have chosen to focus my discussion on factors affecting the overall movements in credit card debt. The bulk of revolving credit in the United States today is held in the form of credit card debt. As the financial crisis developed in late 2008, the aggregate amount of credit card debt outstanding began to fall. Revolving credit has dropped every month since that time and is currently about 15 percent lower than it was at the time of the Lehman Brothers Holdings bankruptcy. Although our economy has experienced other long episodes in which revolving credit growth has slowed, we have never seen such a prolonged period of outright decline."

I find it most interesting that, despite the fact that much of the Crisis of 2008 - 2009 was caused by over-extended consumers who could not afford to pay their debts (including mortgages), that Governor Duke and her counterparts at the Federal Reserve did what was necessary to support the flow of credit to consumers in large part by adopting a near zero percent interest rate policy and by taking bad investments off the books of the nation's banks.  Notice that Governor Duke states that revolving credit (credit is used on an as need basis and does not have a fixed number of payments in contrast to installment credit which has a fixed number of payments) has declined 15 percent from September 2008.  She also notes that such a sustained drop in revolving credit has not previously been experienced by the American economy and that, although consumer spending has risen, revolving credit has continued to decline.  She states that this can happen for three reasons; first, consumers can simply choose to pay cash or charge less, second, consumers can pay off more of their outstanding credit debt every month and third, households can default on their credit balances.

Governor Duke addresses each of the three issues in order:

Firstly, consumers have charged 10 percent less on their credit cards between the third quarter of 2008 and the first quarter of 2010.  Not surprisingly, and much to the chagrin of central bankers who need us to spend so that the economy grows quarter-on-quarter, households have simply elected to spend less.  Having seen many of their family members, friends and neighbours lose their jobs has had a sobering impact on the spending habits of American consumers.  As well, it has had an impact on their attitude toward purchasing items on credit; somewhat more Americans now believe that buying on credit is a "bad idea".  This is in sharp contrast to the leveraging up that American consumers were used to prior to 2008.

Secondly, the decline in outstanding credit balances could also be due to households accelerating payments toward their outstanding revolving credit balances, however, Fed data shows that repayment is having a minimal effect on the drop in revolving credit.  Generally, as the economy improves, households elect to pay off more of their credit card debt; consumers often used home equity to pay off more expensive credit card debt when the economy was strong.  It's pretty hard to do that when the value of your house is dropping.

Thirdly, as the economy worsened, an increasing number of households have found it difficult to pay their credit card bills on time.  The high unemployment and underemployment rates have made it increasingly difficult for some households to avoid defaulting on their credit card balances.  The "charge-off" (the term used when a creditor assesses the balance owed as bad debt) rate stood at about 4 percent in 2007 and rose to more than 9 percent in 2009.  The charge-offs account for about one-third of the drop in credit card balances.

There are other factors involved in the drop in credit card debt.  One additional factor is the drop in the amount of credit available to consumers.  Lines of credit available to card holders have dropped from an average of $26,000 per cardholder in late 2008 to $21,000 in late 2010.  Another factor is the change in the composition of credit card holders from "if you make fog on a mirror when you breathe, you get credit" to more creditworthy clients who pay off their balances every month.  Finally, the number of new credit card solicitations have fallen dramatically to one-fifth of their count in 2006 by 2009.  On the upside, consumers are getting a whole lot less of those annoying bulk mail-outs from credit card companies cluttering their mailboxes day after day.

The upside to the drop in the use of credit cards for companies like Visa is that they work both sides of the street.  Visa also supplies debit cards whose use has not declined in either number of transactions or value of those transactions during the Great Recession.  You see, if you own a credit card company, you can make great returns for your shareholders either way!

Speaking of Visa, let's take a quick look at their Q4 2010 numbers.  Visa had net income of $774 million in the fourth quarter of 2010 and full year 2010 net income of $3.0 billion (both excluding revaluation of their Visa Europe put option).  Their fourth quarter net income number was up 51 percent over the previous year and their full year net income was up 26 percent over 2009.  Here's a quote from Visa's quarterly report:

“We are very pleased with our fourth fiscal quarter and full-year earnings results as we continue to successfully execute on our strategic initiatives while in the midst of a very challenging business environment,” said Joseph Saunders, Chairman and Chief Executive Officer. “Our continued focus, execution and resilience have enabled us to continue to generate solid returns and meaningful growth across our business, products and geographies.”

No kidding.

Back to Governor Duke for the last time.  I find it interesting to watch central bankers and their relationship to consumer credit and debt.  It appears to be a love-hate relationship.  They deliberately lower interest rates to cajole us into spending (often more than we can afford) by taking on credit (often more than we can afford) so that the world's economy will continue to grow and the dreaded spectre of deflation will not rear its particularly frightening head.  Then, when it looks like we might have had a bit too much of a good thing, they get out a stick and try to beat us back from the pile of money they've tempted us with.  It looks rather like they are suffering from a form of fiscal dissociative identity disorder.