Friday, December 12, 2014

Why Are Consumers Pessimistic?

While consumer sentiment has, in general, been on the upswing since the Great Recession, as we can see in this chart from FRED, even at its current level of 93.8, it is just reaching levels that would have been considered average during the period from the 1980s until the Great Recession took hold:

Why the pessimism and why has it taken so long for consumer sentiment to improve?

An analysis by Tim Chen, the founder of NerdWallet and former hedge fund equity analyst, may give us a hint.  His calculations show that, as of December 2014, among all households in the United States, credit card debt averages out to be $7,281.  If we look at only at households that have credit card debt, the average outstanding balance rises to a whopping $15,608.

Let's look at consumer credit as a whole.  Here is a graph from FRED showing the changes in the level of consumer credit, excluding mortgages, since 2006:

You'll notice the decline in consumer credit as the Great Recession took hold of the economy during 2008 and 2009.  Consumer credit fell from a peak of  $2.678 trillion in July 2008 to $2.519 trillion in July 2010, a fall of $159 billion or 5.9 percent.  Since its low point, consumer credit has continued its march upwards, hitting $3.279 trillion in October 2014, a rise of $760 billion or 30 percent from its post-Great Recession low point.

Before we go any further, let's look at two definitions:

1.) Revolving Credit (debt): In this type of debt, consumers pay a commitment fee and are then allowed to use funds as needed.   The outstanding balance does not have to be repaid every month and there are not a fixed number of payments.  The most common type of revolving debt is a credit card.

2.) Non-revolving Credit (debt): In this type of debt, credit cannot be reused after payments are made and the balance must be repaid at the end of the loan period.  Two examples include car and student loans.  

Here is a graph showing what has happened to the level of revolving credit since 2006:

Here is a graph showing what has happened to the level of non-revolving credit since 2006:

Obviously, most of the growth in total consumer credit can be attributed to growth in non-revolving credit.  According to the Federal Reserve, total revolving debt was at $1.002 trillion in December 2007 as the Great Recession began and total non-revolving debt was at $1.613 trillion.  Revolving debt fell to a low of  $833.7 billion in April 2011 as consumers both paid off debt and defaulted on their revolving debt.  During the months during and after the Great Recession when revolving debt declined, non-revolving debt levels actually grew, hitting $1.849 trillion in April 2011.

Let's focus on the changes to the level of non-revolving debt.  As you can see from the graphs, non-revolving debt levels have mushroomed, hitting $2.396 trillion, up $783 billion or 48.5 percent from the beginning of the Great Recession.  This is the steepest growth rate in non-revolving debt since record-keeping began in the mid-1940s as shown on this graph:

Since non-revolving debt includes car loans, here is what has happened to car loan levels since 2006:

There was a rather precipitous drop in car loans during and after the Great Recession but, since hitting a low point of $698 billion in the third quarter of 2010, the volume of car loans has risen by $245 billion or 35 percent in the third quarter of 2014. 

At the same time as non-revolving debt levels were rising, here is a graph showing what happened to inflation corrected hourly compensation levels since 2006:

Obviously, real wage growth has been very modest over the past decade, putting consumers further and further behind as they take on more and more debt.  While consumer sentiment has improved since consumers were hammered during the Great Recession, the growing levels of consumer indebtedness and the lack of growth of real wages is likely to continue to keep consumer sentiment at low levels not seen during most other economic growth phases.  If, as predicted, interest rates rise, debt-ridden consumers may find that they are even more pessimistic than they already are.

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