Recession and Credit Crisis and Banking & Finance and Opinion and Economic Analysis and Economy

HICKS: Recession results in 'great deleveraging'

October 31, 2009

The recession that has just passed will leave a lingering bitter taste in many mouths.

On virtually every meaningful measure, this recession stacks up as only the third or fourth worst post-World War II recession, but its effects are much more profound in a few areas. One area that will be most apparent is the changes the economy has wrought on consumer credit. I call it the “great deleveraging.”

From 1995 through 2008, consumer credit service payments rose from just under 11 percent to a high of 13.6 percent as a share of personal income. Over the past 18 months, household debt has plummeted roughly $200 billion. As a consequence, the average American household has seen its debt load tumble by $1,500 since the start of the recession. I think some of the changes to credit markets shaped by this recession will be long-lasting. Some important implications of these changes are worth exploring.

Now, and for the foreseeable future, I expect consumer credit to be much tighter than it has been for decades. The effect will be uneven. Most American households do not have a credit problem. For example, for those of you who abide by Mrs. Hicks’ legendary stinginess, the change in lending practices will go unnoticed (she even canceled ESPN at the start of football season). Banks thirst to lend to about half of households, or all of those with little debt.

The folks who will notice problems in borrowing fit two characteristics. First, households with above-average debt-to-income ratios will find constraints to credit-card limits, the prime source of borrowing. The other group will be those with low earnings expectations, or with an uneven history of dealing with debt.

Many will see this as a return to a more prudent time and will welcome the changes. But, there are also downsides. At least some share of low-income households borrowed now to make their later lives more prosperous. The purchase of a car to get to work or taking loans to pay for college might best be viewed as an investment. Banks will find it difficult to make the distinction between these types of purchases and that of a 42-inch flat-screen TV (which I find useless this football season).

College students will be among the first to feel the effect of tightened credit. Just a generation ago, new cars and credit cards were virtually unknown among college students, but that had changed in recent years. Today, however, the free market has turned back the clock and credit availability has tightened. This will affect student lifestyles and choice of majors.

Low-income and high-debt households will find banks and credit card issuers increasingly unwilling to extend credit limits. In the end, this great deleveraging will leave us with a higher saving rate and less in debt. At least some of us will have less to worry about.•

__________

Hicks is an associate professor of economics and director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

ADVERTISEMENT

Recent Articles by Mike Hicks

Comments powered by Disqus