– Rising interest rates are threatening the US consumer credit bubble
Interest rates continuously hitting multi-year peaks, rapidly increasing debt default rates, and banks tightening credit flows are real risks to the US consumer credit bubble.
precarious situation
A recent survey by Clever Real Estate has revealed alarming numbers about the credit card debt situation of American consumers.
Specifically, the average credit card debt is $5,875 per person. Of which, Gen Y (those born between 1981 and 1996) owes the most, with an average of approximately $6,800 per person.
On average, each person has to spend $1,506/month to pay off credit card debt, equivalent to about 30% of the net income of the American people. Gen Y continues to lead the way, spending up to $2,410/month.
23% cardholders say they are getting deeper into credit card debt every month, 33% have to borrow from one card to pay off debt on another. 23% cardholders say it will take them more than 5 years to pay off their credit card debt.
53% have spent up to their credit card limits, including 29% cardholders who use up their limits every month. According to the US Federal Reserve (Fed), total outstanding credit card debt in the US surpassed the $1,000 billion mark last September and is currently at a historic peak of $1,020 billion.
43% of cardholders surveyed said they had missed a credit card payment in the past five years. The rate in 2023 alone was 14%. The most common reasons for missing a payment were forgetting (36%) and having to prioritize buying necessities like food (36%).
Credit cards allow interest-free spending for 45-60 days, but if the cardholder is late in paying, the interest rate will skyrocket much higher than when borrowing to buy a house or car because the nature of a credit card is an unsecured loan tool, without collateral.
As the Fed continues to tighten monetary policy to combat inflation, credit card interest rates have also risen rapidly, reaching an average of 21.2%/year in August 2023. This is an unprecedented high since comparable data began in late 1994.
Many Americans don't even know credit card interest rates are that high. According to a survey by Clever Real Estate, 411 percent of respondents said the average interest rate is below 201 percent, and about 131 percent said it was below 101 percent.
The outlook for credit card holders is no better in 2024, as Fed officials are expected to keep current policy rates unchanged to fight inflation and not rush to ease.
Credit card interest rates in the US are at an all-time high, according to statistics for the months of February - May - August - November every year.
Risk of collapse
Americans' credit card debt situation is in a precarious state at a time when financial conditions are tightening and banks are restricting lending.
According to data from the St. Louis Fed, the percentage of banks tightening credit card lending standards has steadily increased to 36.4% in the third quarter of 2023, equivalent to the period of the 2020 COVID-19 recession and the 2008 economic crisis.
This is understandable because when interest rates are high, banks do not need to lend as much and can still earn as much profit as before. Therefore, banks will prioritize lending to consumers with high credit scores and cut back on those considered risky.
The tightening of lending has not only affected credit cards but also commercial and industrial loans. The proportion of US banks tightening lending standards for this group has increased for the fifth consecutive quarter, reaching 50.8% in the third quarter.
The last time banks tightened lending conditions this much was during the 2020 recession and the 2008 crisis.
Banks are selectively lending to those deemed safe, rather than lending widely as before, partly because customers' ability to repay has weakened significantly.
The rate of late credit card payments at US commercial banks has increased for seven consecutive quarters to 2.77% in the second quarter of 2023, the highest in more than a decade.
Considering small banks (outside the top 100 in terms of asset size), the situation is much worse, with the late payment rate reaching 7,51%, an unprecedented high since statistics began in 1991. During the 2008 crisis, this rate was only up to 5,61%.
This reality shows that consumers who own multiple credit cards are in dire straits. When forced to choose, cardholders prioritize paying off balances on cards issued by large banks to maintain good relationships, leaving smaller banks to suffer more.
Crowding out effect
Banks are reducing lending partly because profits per loan are higher than before (due to rising interest rates), and partly because customers' ability to repay their debts has weakened. Another notable reason is that banks no longer have as much money to lend as before.
The Fed's successive interest rate hikes caused the bond portfolio values of many banks to plummet, and many names collapsed in 2022, such as Silicon Valley Bank, First Republic Bank, Signature Bank, etc. Depositors immediately left risky commercial banks with low deposit interest rates, then turned to money market funds.
Between April 2022 and September 2023, total deposits in the U.S. banking system fell by about $800 billion. During the same period, money market funds for retail investors increased by $600 billion.
These funds increase their investment in US Treasury bonds and bills to earn profits of 4 - 51 TP3T/year, much higher than the deposit interest rate of 0.1 - 0.21 TP3T/year.
Indirectly, the US government is competing with the banking system for capital. Money that should be deposited in savings accounts to be lent out to the economy is instead being absorbed by the US government through the bond channel and then used for public spending. This is the crowding out effect in economics, when public spending reduces private spending.
The U.S. government desperately needs money to pay for its many welfare programs and to pay off debt that is due to avoid the risk of a repeat of the annual shutdown. But U.S. businesses and consumers also need capital to pay off old debt and make new investments. The current tightening of lending conditions by banks is creating another threat to the U.S. credit bubble.
Source: Investing
