Thursday, December 7, 2006

Consumer Credit Falls

From the AP

Consumer borrowing fell in October by the largest amount in 14 years, reflecting a big drop in auto loans.

The Federal Reserve reported Thursday that borrowing declined at an annual rate of 0.6 percent in October following a revised 2 percent increase in September. It was the biggest drop since a 1 percent plunge in October 1992.

Analysts cautioned against reading too much into the one-month change, noting that the consumer credit figures can be subject to major revisions. The 2 percent rate of increase in borrowing in September had originally been reported as a 0.6 percent decline.

However, economists said they are forecasting a slowdown in the rapid pace of borrowing of the past two years as consumers start to feel less wealthy now that housing prices are no longer surging to record levels.

"The wealth effect from rapidly rising home prices is gone now and that should mean that consumers will be less willing to take on debt," said Bill Hampel, chief economist for the Credit Union National Association, an industry trade group.

First, let's note these numbers are pretty wild and can change. However, this is the second month in a row where the initial number has been negative. At some point the first number will be right.

Thanks to record low interest rates consumer debt has exploded during this expansion, rising from 74% of GDP in the fourth quarter of 2001 to over 90% in the third quarter of 2006. Blogger Calculated Risk has calculated that without home equity extraction US GDP growth would have been half as high for this expansion. In other words, consumer debt has been exceedingly important as a funding source for this expansion. There is no bright line economic rule about how much consumer debt is too much. But, I do feel fairly certain that when household debt is greater than 90% of GDP and over 120% of national income, there is a problem.

Also note Hampel's statement above regarding the wealth effect from decreasing housing values. What's important about this statement is the negative impacts of a slowing housing market may just be starting. Instead of being an outright hard landing crash, housing's slowdown may cause death by a thousand cuts. Lack kof equity extraction here, less consumer spending there etc....