Consumers continue to scale back their credit card debt at an ever-increasing pace, according to figures released by the Federal Reserve on October 7. For the 11th month running, revolving credit debt, which is mostly a measure of credit cards with unpaid balances, dropped in August by an annualized 13.1 percent, to $899.4 billion.
Consumers are pulling back on credit card debt and increasing their savings, in part spurred by the continued economic uncertainties and rising unemployment rates. Many industry experts also attribute the drop in credit card debt to tightening credit card terms and rising interest rates. In anticipation of the new credit card law that steps into effect in February, credit card companies have hiked interest rates, increased fees, and shifted many credit cards from fixed to variable rate cards.
At the same time as consumers are paying down credit card debt at ever-increasing pace, the personal savings rate is going up, to 4.2 percent in July from almost zero just a few years ago.
August marked the 11th consecutive month in which credit card debt has declined. The outstanding credit balances on card issuers’ books decreased by almost $10 billion, and total outstanding credit card debt is down about $75 billion from its all-time high of $975 billion in September of 2008.
The numbers certainly look encouraging, but don’t bring out the champagne just yet. While increased consumer frugality is widely cited as the key driver of declining credit card debt, other factors may be equally, or more, at play: record high credit card charge-offs and scaled back credit card lines.
The number of credit card charge-offs, or credit card defaults, is a measure of credit card debt which credit card companies have written off as uncollectible. A credit card account is generally considered a charge-off when it is more than 60 days old. According Moody’s Investors Service, credit card defaults have almost doubled over the last year, from 6.8 percent in August of 2008 to 11.49 percent in August of 2009. Default rates at this level means that card issuers are writing off 11.49 cents for every dollar of credit card debt on the books.
According to the industry newsletter insideARM.com, once charged off, credit card debt no longer shows up in the Fed’s consumer credit figures. If this is correct, a large proportion of the pull-back in credit card debt does not result from consumers paying down their debt, but rather cardholders walking away from their debt.
Further, outstanding credit card debt might be down because consumer charging has been curtailed by cut-backs in credit card limits. One third of all cardholders, about 58 million consumers, had their credit limits cut from April 2008 to April 2009, according to FICO, formerly Fair Isaac Corp. Credit card companies have slashed outstanding credit lines by more than $1.25 trillion over the last year; 10% of credit card accounts have been closed. Some banking analysts predict that credit card companies will continue to scale back on credit limits and that total credit card lines could decline as much as 45 percent by the middle of 2010.
In short, the news about shrinking credit card debt, unfortunately, may herald as much bad news as good news. While there is no doubt that consumers have pulled back on credit card spending and many have made steps to reduce their credit card debt, other factors come into play, and ultimately, it remains to be seen which are the main drivers of the decline in overall credit card debt.
