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Are American Debt Slaves Getting in Trouble Again?

By: Wolf Richter

 

The economy depends on them, but they’re cracking.

American consumers are holding $1 trillion in revolving credit, mostly in credit card debt. So how well is this segment of consumer debt holding up?

Synchrony Financial – GE’s spin-off that issues credit cards for Walmart and Amazon – disclosed on Friday that, despite assurances to the contrary just three months ago, net charge-off would rise to at least 5% this year. Its shares plunged 16% and are down 27% year-to-date.

Credit-card specialist Capital One disclosed in its Q1 earnings report last week that provisions for credit losses rose to $2 billion, with net charge-offs jumping 28% year-over-year to $1.5 billion.

Synchrony, Capital One, and Discover – a gauge of how well over-indebted consumers are managing to hang on – have together increased their Q1 provisions for bad loans by 36% year-over-year. So this is happening.

Other worries about consumer debt in the US are piling up. The $1.4 trillion in student loans are already in crisis, though the government backs them, and they cannot be charged off in bankruptcy. Mortgage debt is still hanging in there, given the surge in home prices that make defaults unlikely. But of the $1.1 trillion in auto loans, subprime loans packaged into asset backed securities are getting crushed by net charge-off rates that are worse than during the Financial Crisis.

The US economy is fueled by credit. Americans turning themselves into debt slaves makes it tick. Take it away, and what little growth there is – nearly zero in the first quarter – will dissipate into ambient air altogether. So it’s time to take the pulse of our American debt slaves

In a new study, life insurer and financial services provider Northwestern Mutual found that 45% of Americans that have debt spend “up to half of their monthly income on debt repayment.” Those are the true debt slaves.

Excluding mortgage debt, American carry an average debt of $37,000. Of them, 47% carry $25,000 or more, and more than 10% carry $100,000 or more in debt, excluding mortgage debt.

Most of them expect to get out of debt before they die, but 14% expect to be in debt “for the rest of their lives.”

This debt adds stress. About 40% said that debt has a “substantial” or “moderate” impact on their financial security; and about as many consider debt a “high” or “moderate” source of anxiety. Given the rising defaults, this is likely to get worse.

 

And what changes would most positively affect their financial situations? The top two: earning more money (29%) and getting rid of debt (26%). Alas, those two, for many people, are precisely the most elusive factors in the current economy.

But there is a lot of irony in how Americans look at debt. The study asked them what they would do with a $2,000 windfall: 40% said they’d pay down debt. And this is the irony: they’d pay down their maxed out credit cards, but a few months later, their credit cards would be maxed out again, and thus that $2,000 would be consumed. Because the money always has to get spent.

It’s not like consumers don’t know this. According to the study, one quarter of Americans flagged “excessive/frivolous” spending as the financial pitfall they are prone to. And how are these debt slaves keeping the plates spinning? According to the study:

  • 35% said they pay as much as they can on each of their debts each month.
  • 19% said they pay off debts with the highest interest first and make minimum payments to others.”
  • 18% (and 25% of Millennials) said they pay what I can when they can.
  • 17% make minimum monthly payments to each creditor.

The study didn’t say how many of them are beginning to fall behind on their debts. But that number is growing, as the soaring net charge-offs at Capital One, Synchrony, and Discover show.

“One of the hardest challenges is resisting the urge to splurge on items that are beyond our budget,” explained Rebekah Barsch, VP of planning, Northwestern Mutual. “While giving into temptation can feel good in the short-term, it often contributes to an ongoing cycle of buy and borrow that can become hard to escape.”

All the more so because buy-and-borrow has become the replacement American dream for a large number of people – with the corollary: if you can borrow more, you can buy more. But these debt slaves are a crucial driver of the economy. Spending money they don’t have on goods and services they cannot afford and may not need keeps the economy from sinking. If they ever started living within their means and paying off debt as they go, the economy would quickly reveal its true colors

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