Americans have driven up their credit balances at a record pace this year. The doomsayers say this clearly shows that households are struggling in the face of the highest rates of inflation since the early 1980s and have no choice but to go into debt to make ends meet. The reality is not as dire. In fact, consumers’ finances are near the best shape ever, giving them a long runway until rising debt obligations become a problem.
It’s easy to understand the worry. Four of the biggest monthly jumps in consumer credit on record have come this year, with outstanding balances growing by an average of $33.1 billion a month over the past six months, according to Federal Reserve data. To put that in context the monthly average in all of 2019 was a little less than half that amount at $15.4 billion. The numbers are certainly shocking, but there are indications that they are mostly healthy and normal.
First, consider revolving credit, which includes credit cards. That form of credit contracted dramatically early in the pandemic as consumers had fewer options to spend and used excess savings and stimulus checks to pay down balances. Now, consumers are mostly just playing catchup, as the amount of revolving credit outstanding remains below the pre-pandemic trendline. If it blows past trend, that would indicate broader inflation-induced distress, but the financial system broadly isn’t even close to that point. Of course, many lower income households are suffering from the spike higher prices and are being forced to reach for their credit cards. But there’s no sign of a debt problem brewing broadly that could damage the economy.
Non-revolving credit is a slightly different story. That’s mostly education and car loans, but it also includes financing for other big-ticket goods such as boats and trailers that surged in popularity during the pandemic. That category has seen a pandemic-era expansion that exceeds trend, and automobiles, which account for 39% of non-revolving credit and 30% of consumer credit, seem to be the main culprit. Chalk that up to the extraordinary runup in car prices in 2021 and, perhaps to some degree, the extra interest in car ownership due to public health concerns. Many people who once used public transportation have preferred to opt for the better social-distancing of a vehicle.
Although much smaller than the auto segment, the real juggernaut of loan growth was the “other” category of non-revolving credit, including the aforementioned maritime toys. Early in the pandemic, coastal communities saw an explosion of interest in boating in response to social distancing guidelines. But that category is too minor to have a broad impact. Moreover, boat owners typically aren’t living paycheck-to-paycheck as a general rule, so cross that off the list of would-be drivers of a structural leverage crisis. If there was cause for concern in the consumer credit data, it would be found in the nonrevolving credit section. But growth in that segment peaked earlier in the year and showed some signs of moderation in the most recent report. The latest month’s increase was the smallest since January.
Finally, the household debt service ratio -- the ratio of debt payments to disposable income -- is near historic lows. That’s thanks to opportunities to refinance debt at low rates in 2020 and 2021 and to the influx of trillions of dollars of government cash during the Covid-19 pandemic. As painful as inflation is, homeowners with fixed-rate mortgages, which account for the vast majority of home loans, may have benefitted from wage increases while their biggest liabilities remained the same or were renegotiated at lower rates. Taking consumer debt and home loans together, the total burden remains extremely modest.
None of this means that there’s no cause for concern. The economy faces elevated odds of a recession due in part to the Fed raising rates quickly to get inflation back under control, and many economists predict unemployment may increase in the process. No job means no income, and debt service ratios that look so low today could rapidly surge if the labor market stumbles. No group would suffer more than lower-income households that have already started to spend their cash stockpiles to keep up with inflation. But from a systemic perspective, household finances appear to be starting from a position of strength. For now ,at least, the runup in consumer credit looks like much ado about nothing.
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