Consumers Not Ready For Another Credit Binge

Last week, two key reports on the state of the financial and consumer sectors were released. By all accounts, the consumer deleveraging cycle remains intact, despite an apparent willingness on the part of banks to reengage the lending machine. That will continue to pressure economic growth in the coming quarters, similar to prior debt deleveraging cycles.

At the start of the week, the Federal Reserve Bank of New York released its quarterly review of household debt and credit, an aggregated view of trends in consumer debt. According to the NY Fed, aggregate consumer debt fell 1.1% in the fourth quarter to $11.53 trillion.

The largest decline in debt outstanding occurred in housing-related debt, which saw mortgage balances fall an additional $134 billion in the fourth quarter. Unfortunately, the housing situation remains tenuous as 2.2% of mortgage balances moved into delinquency.

One of the primary reasons for the continued persistence of high delinquency is the number of homeowners estimated to be “underwater.” Mortgage data provider CoreLogic estimated there were 11.1 million homeowners underwater in the fourth quarter, or roughly 23% of all residential properties that have a mortgage. In total, CoreLogic believes there is more than $715 billion of negative equity weighing on the housing markets.

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There is a degree of good news on the horizon. The number of delinquent loans grew exponentially from 2008 through early 2010, before beginning a slow, gradual reversal. With the recent announcement of a $25 billion mortgage settlement, delinquent balances are likely to fall more quickly. This is due in part to the fact that $10 billion is earmarked for principal reductions and loan modifications for borrowers nearing foreclosure. Another $3 billion is going to help underwater borrowers who remained current on their payments.

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The other bit of encouraging news came from the Federal Deposit Insurance Corporation (FDIC) in the form of its Quarterly Banking Profile. Based on FDIC data, bank profitability reached a 5-year high in 2011.

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At the same time, the number of banks failing or considered “problematic” is on the decline. In the fourth quarter, 18 financial institutions failed and the number of “problem” banks fell from 844 to 813.

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With banks feeling more sanguine about their current situation, they have become more willing to lend capital to consumers and institutions. Loan balances were up $130 billion in the quarter, representing the third consecutive quarter of loan growth. It also represented the largest quarterly increase since 2007.

Although banks are seemingly more able to lend, consumers are simply not in the frame of mind to embrace another credit binge. Bank lending will provide obvious benefits to the economy, but until consumers feel more secure in their own financial situations, the push and pull between lending and borrowing will act as only a modest stimulant to the economy.