One Last Binge

A little deep in the weeds here, but via Yves Smith we learn that the reduction of consumer debt since the Great Recession started isn't because of people paying off their bills...it's because they are getting cut off and going bankrupt instead.

The sharp decline in U.S. household debt over the past couple years has conjured up images of people across the country tightening their belts in order to pay down their mortgages and credit-card balances. A closer look, though, suggests a different picture: Some are defaulting, while the rest aren’t making much of a dent in their debts at all.

First, consider household debt. Over the two years ending June 2010, the total value of home-mortgage debt and consumer credit outstanding has fallen by about $610 billion, to $12.6 trillion, according to the Federal Reserve. That’s an annualized decline of about 2.3%, which is pretty impressive given the fact that such debts grew at an annualized rate in excess of 10% over the previous decade.

There are two ways, though, that the debts can decline: People can pay off existing loans, or they can renege on the loans, forcing the lender to charge them off. As it happens, the latter accounted for almost all the decline. Over the two years ending June 2010, banks and other lenders charged off a total of about $588 billion in mortgage and consumer loans, according to data from the Fed and the Federal Deposit Insurance Corp.

That means consumers managed to shave off only $22 billion in debt through the kind of belt-tightening we typically envision. In other words, in the absence of defaults, they would have achieved an annualized decline of only 0.08%.

Bottom line: nearly all the decrease in consumer debt is banks writing off bad loans that didn't get paid back.  Millions of Americans are having to burn out every last dime on their credit cards to make ends meet with declining wages and an increase in basic cost of living.  What we're seeing now is the "snapback" effect:  banks are writing off these loans, consumers are taking massive credit score hits, and they're out of the game.

As more and more Americans lose their credit due to banks tightening up, there will be a massive drop in consumption and soon...in fact it's already under way.  The consumer engine that drives our economy is locking up.  The results?  Nasty.

The only thing keeping our economy going right now is ramping up debt.  When that breaks down, the whole thing is going to go.  And when it does, it's going to take our standard of living with it.