Is the economy improving or not? By many measures, it is; it is just doing so very slowly. However, there are some disturbing undercurrents to the growth. The collective debt of Americans remains the elephant in the room, or perhaps the elephant in our wallets.
Consumer spending has increased since the Great Recession, although the increase has flattened out according to the last report from the Bureau of Labor Statistics (BLS). Since our economy is primarily consumer-driven, that should be relatively good news. It would be… except that too many consumers are not paying for what they buy.
A recent study by the Urban Institute found that 35% of Americans have had debt turned over to collections. That is a staggering 77 million Americans, with an average amount in collections of $5,178. That is not the total debt held – just debt in collections.
A more recent aggravating factor is the emergence of a subprime auto loan bubble, mirroring that of the housing bubble that burst in 2007. Too many people were extended credit that they did not qualify for based on their credit scores and current income, or they overextended themselves by taking out outrageously long terms to lower monthly payments.
Auto loans with 7-8 year terms are available now – probably longer than the borrower will keep the car.
With the poor job outlook, and stagnant wages for those who do have jobs, an increasing number of people are unable to make their auto loan payments. As a result, one employment category is booming – the repo man.
Auto repossessions increased by 70.2% in the second quarter of 2014, and a great deal of that was through alternative financing (outside of banks and credit unions, as well as the financing arm of the automakers). Meanwhile, car loans are at a peak value of $910 billion at the end of Q1 2014.
Given the similarities to the housing bubble and subsequent crash, should we expect a “car crash”?
Keep in mind that just as in the mortgage crisis, these debts are securitized and sold on the market as bonds backed by the debt. These bonds are still in high demand by investors, even though there is currently a government probe of the lending practices behind them.
There is one major difference in this case – they appear to be represented with the proper amount as risk. As long as investors are not misled, they will adjust their holdings based on any increases in defaults.
The repossession increase and the car loan default rate are just indicative of the collective debt problem throughout America. Credit card debt alone averages $15,480 per household, and the total of student debt has overtaken credit debt as the number one source of American debt.
According to the St. Louis Fed, the total outstanding consumer credit is $3.247 trillion dollars. Given the current U.S. population of approximately 319 million people, that equates to a little over $10,000 for every man, woman, and child in the U.S.
What does this all mean for investors? The main takeaway is that consumer spending is unlikely to be robust enough to sustain anything but weak growth for quite some time. Even when wages do increase for the middle and lower classes, consumers will need to use some of the increase to lower their debts – otherwise, the positive effects will only be temporary and the debt “hangover” will be even larger.
We can hope for faster growth, but we should probably expect slow growth in the near future.