Consumer Credit Cracks

#70: The era of immaculate credit is over.

In the early days of the pandemic, I was concerned about the state of the economy. COVID brought a sudden and extreme halt to a wide range of business activity. Temporary unemployment surged and over two million jobs were permanently lost.

Deep uncertainty around unemployment, demand destruction, real estate vacancy, and small business closures seemed to be patched up with band-aid solutions. As pandemic relief programs ended, we would see the lasting disruption to the economy and the effect on the consumer, so I reasoned.

But quickly, those views were contradicted by the data. The scope and scale of government support - driven by a massive expansion in money supply - had done more than plug the hole. Nearly indiscriminate support in the form of forgivable PPP loans, stimulus checks, enhanced unemployment, child tax credits, eviction moratoriums, student loan forbearance, and ultra-loose monetary policy had left the consumer in a remarkably strong position overall.

Rather than stagnating due to unemployment, aggregate incomes surged on the back of government transfers financed by the Federal Reserve. Credit cards were paid down, mortgages were re-financed, corporate profits exploded, and the stock market roared. Consumer credit improved to the best on record.

Rather than doom and gloom, the economy headed in the opposite direction of speculation and excess. The springboard was loaded with pent-up savings, a whiplash in manufacturing activity, a surge of re-hiring, and the reopening of social activity.

It became clear very quickly that betting against the consumer was a losing trade. Regardless of one’s normative perspective on the wisdom and scale of fiscal policy, the objective reality is that many people were flush and eager to spend.

For this reason, I’ve been incredibly wary of doubting the consumer ever since. Even as tighter policy has led many to make recession predictions over the past year, I have resisted - not because I’m smarter than anyone else, but because I was wrong first.

But even the indefatigable eventually lose their breath. Today, there are growing signs that all is not well with the consumer.

The tank of excess savings may finally be running on empty. The gangbusters job market is returning to earth. Real incomes remain stifled due to years of high inflation. Pandemic-era handouts have (mostly) come to an end and student loan payments will resume. Meanwhile, the rapid tightening of monetary policy has led to a surge of interest burden and tightening of credit.

Cracks are showing. As a growing number of individuals struggle to make ends meet, consumer credit has deteriorated and shows little signs of moderating. No longer can this weakening simply be ascribed to a “normalization” from the immaculate credit conditions of the pandemic-era. Delinquencies across credit cards, auto loans, and consumer loans have reached the highest level in a decade and the trend is likely to worsen. The strength of the U.S. consumer may finally be reaching its limits.

Excess Savings and the Great Re-levering

Part of the trouble with analyzing “excess savings” is that it’s surprisingly hard to pin down. Aggregate data ignores crucial differences between income cohorts, and money is not destroyed when it is spent, it merely changes hands. Nevertheless, there are a couple of measures that help frame the issue.