Consumer Debt Market Shows Signs of 'Healing'

As 2012 drew to a close, the overall consumer debt market showed "some clear signs of healing" from the deepest financial downturn since the Great Depression, says newly released research from the Federal Reserve Bank of New York.

At the same time, Fed economists used a first-of-its-kind press briefing Thursday to send a warning that rising default rates for student loans are putting pressure on consumers and could crimp the recovery.

Total consumer credit increased in the fourth quarter of 2012 by less than 0.5% or about $31 billion, according to the New York Fed's quarterly report on household debt and credit, released Feb. 28. The slight uptick in total consumer debt marks the first time that households have increased their total, in aggregate, since the spring of 2008.

"While it's too soon to conclude that a trend has been established in which households are beginning to increase their debts again, there are signs that the four-year long contraction is slowing," said New York Fed director of research James McAndrews. Whether the fourth quarter marked a turning point toward the expansion of consumer borrowing -- and resulting higher economic growth -- won't be known for several more months, he added.

The housing market is beginning to pick up substantially, said McAndrews, just as consumers are gradually increasing the total amount of household debt they carry.

Plus, more households are also paying back their bills on time, he said, showing that consumers are getting a better handle on their debts.

The modest uptick in debt and continuing decline in most delinquencies are particularly significant, he said, given the history consumers have had with debt since the recession.

The New York Fed's quarterly report "has documented the enormous rise in consumer delinquencies and defaults as the housing bust and the Great Recession unfolded, and, over the last several years has provided an in-depth look at a very large reduction in household debt -- the largest we have ever witnessed."

Card balances' slight rise

Credit card balances grew by $5 billion in the final quarter of the year, contributing to the overall boost in household borrowing. This was the second consecutive quarter that credit card balances grew.

Despite the increase in card debt toward the end of the year, consumers still charged significantly less in 2012 than they did in 2011. Overall, balances fell by $25 billion -- 4% -- for the full year of 2012, according to an additional presentation by New York Fed Senior Vice President Wilbert van der Klaauw.

Delinquencies longer than 90 days saw a slight uptick in the quarter, however, to 10.57% of balances from 10.45%. The rise was the first since 2011, but van der Klaauw said the result could be a blip in the figures, which are not adjusted seasonally.

"I would emphasize the longer-term trend here," he said, adding that coming quarters will show whether delinquencies in fact returned to an upward path. Overall, late payments on credit cards fell substantially in 2012 compared to the previous year.

Consumers are still trying to recover from the Great Recession, said Don Dutkowsky, a professor of economics at the Maxwell School of Citizenship and Public Affairs at Syracuse University.

As a result, many consumers remain exceptionally cautious about the amount of debt they're willing to take on, he says, particularly since the economy shows few signs of roaring back to its pre-recession level any time soon.

"It's hard to place complete confidence in the economy where it stands right now," Dutkowsky said. "It is a fragile recovery at best, which has gotten waylaid several times ... We're still far from fully recovered and far from healthy and robust as an economy. So consumers are being careful because it's their jobs that are on the line."

Inside the report

Each quarter, the Federal Reserve evaluates approximately 40 million consumer credit reports to take Americans' credit-using pulse.

Some of the highlights of this quarter's report include:

Banks remain tight about the amount of credit they're willing to lend to new and current customers. Credit card limits -- the amount of debt that banks allow consumers to borrow -- declined by $9 billion in the fourth quarter of 2012 (about 0.3%).
Consumers don't appear eager to add new cards to their wallets. Slightly more consumers opened new accounts as the year drew to a close. However, the increase was small and followed two consecutive quarters in which the number of open credit card accounts fell.
Consumers are also slowly increasing the amount they borrow on other types of loans. Total consumer credit -- the amount of debt outstanding on all loan types -- grew to $11.34 trillion (0.3%) in the fourth quarter of the year. In particular, auto loans and student loans dominated that growth. However, as the Fed notes in its report, that's still well below the amount of debt consumers accumulated before and during the recession. At its peak, total consumer credit hit $12.68 trillion in the third quarter of 2008, according to the Fed.

Student loan warning sounded

While investment in education can be expected to yield long-term economic benefits as it boosts people's incomes, student loan debt loads are cutting into borrowers' ability to take on other forms of credit, Fed economists said.

Student loan debt "is a growing concern" Senior Economist Donghoon Lee said during his segment of the presentation. "In relation to other types of household debt, the increase in student debt is unique."

Student loan debt nearly tripled from 2004 to 2012, continuing on its growth trend through the financial crisis and recession, while other forms of lending cooled. Higher costs of education and more people opting for college and graduate school both contributed to the rise, Lee said.

Student loan delinquencies continue to rise while other types of household debt see firming repayment. The fourth-quarter's 11.73% 90-day-plus delinquency rate for student loans is up from 8.45% a year earlier.

Reported delinquency rates are understated, Lee said, because a large portion of loans are not in repayment status. "Nearly one-third of borrowers in repayment are delinquent on student debt."

Not surprisingly, he said, people with high student loan debts were less likely to borrow for a house or take on other forms of consumer debt.

Asked whether the trend will hamper future growth, van der Klaauw said, "Obviously, the accumulation of student debt is an issue; delinquency is an even bigger issue."

Looking ahead

In the final quarter of 2012, many consumers were confronting an unusual amount of uncertainty about their finances thanks to ongoing fiscal debates in Congress about what to do about government taxation and budget cuts, according to experts. "I think it would have been hard to avoid," said David Nice, an associate economist with Mesirow Financial. "It was everywhere."

Now, much of that uncertainty still hasn't been resolved, thanks to continued government gridlock over deep cuts in federal spending that are scheduled to take effect Friday.

That, in turn, could have a negative effect on consumer spending, say experts, which could help stymie the economy's recovery. "This kind of economy is kind of like a sick patient that is subject to get infections or something that goes around that knocks you back in the hospital again," said Syracuse University's Dutkowsky. "This is what we hope won't happen." Yet the economy is still far from robust and fully functioning, and not yet strong enough to "ward off any headwinds that come about."

CreditCards.com senior reporter Fred O. Williams contributed to this account.