US unsecured credit: the next bubble to burst?

  • By Elizabeth Fry

A new report reveals US household debt is increasingly out of kilter with consumer income which could be a warning sign of a looming economic shock.

Aite Group’s latest report examines macroeconomic indicators that, ten years later, look eerily similar to those that came before the financial crisis of 2008.

In the months that preceded the financial crisis of 2008, US household debt had just surpassed a new high of US$12 trillion, with non-housing debt making up US$2.62 trillion, the US research house found.

While the current housing debt remains relatively flat to the pre-recession numbers, the non-housing debt has grown 31 per cent in the last 10 years.

The larger concern is that two-thirds of that debt, or US$2.21 trillion, is unsecured debt, according to Kevin Morrison, an Aite Group analyst.

Warnings signs

“Clear warning signs signify that the overall US consumer household debt is once again out of proportion to consumer income,” explains Kevin Morrison, an analyst at Aite Group.

“Banks are increasing loan-loss provisions as delinquency rates continue to trend upward on unsecured debt.

“Another crisis potentially looms with no collateral to assist in a recovery."

On the surface, he said, the US economy appears to be doing well considering stocks are at an all-time high, unemployment is holding at 4 per cent, loan loss rates are near 2 per cent, and the federal funds rate is at 1.75 per cent with three more increases expected for 2018.

Further, recent tax changes have spurred corporate investment and wage increases in most sectors, which has continued to drive consumer spending.

Wrong signals

While these numbers appear to represent strong growth and increased consumer confidence, some contra-indicators should be taken into consideration.

Firstly, the current loan loss rate of 2.0 per cent of all reported debt is distorted by historically low mortgage loss rates.

Second, while overall credit card debt is relatively flat to prerecession numbers, 90-day delinquencies on both credit card and auto loans have been increasing over the last two quarters.

Third. the student loan 90-day delinquency rate is above 10 per cent.

“While some may take comfort in a stable housing market and strong economy, the younger generations appear to be accruing debt at an unsustainable pace without a clear understanding of how much credit costs and how long it will take to pay it off,” Morrison argued.

Overly optimistic voices

In early 2007, Morrison explained, a few voices in the financial sector were attempting to be heard over the rants of optimism regarding the strength of the economy and financial markets.

In his view, mainstream media focused on experts who touted indicators that bore only good news while ignoring the warning signs.

"The result of that ignorance was the loss of billions of dollars of investment, near-record unemployment, and long-term financial impacts for one generation about to enter retirement and another just entering the job market." 

It appears to him that as cyclical recovery periods shorten so do the memories of everyone involved.

In the months preceding the financial crisis of 2008, the loan loss rate was at 2.4 per cent, unemployment was at 5 per cent (the highest it had been in the previous two years), and the average savings rate for US households was 2.6 per cent, recovering from -1 per cent in 2006, the report found.

A strong economy has heightened consumer confidence and issuers have loosened underwriting criteria for near-prime and subprime credit segments.

A growing percentage of consumers with lower credit scores are now accruing debt.

"The potential risk to the economy is that the consumer segments that appear to be carrying balances are also lower-income, younger cardholders who are at the greatest risk of becoming over leveraged."