Loosening the Purse Strings

CUNA’s economists forecast loan growth of 2% this year and 5% next year.

August 22, 2011

The recent pause in eco­nomic growth has caused many people to wonder whether the economy might be headed for a double-dip recession.

A related question on the minds of credit union leaders: When will their members resume bor­rowing?

Recent changes to the household sector’s financial condition show promise in both of these areas.

During the decades leading up to the Great Recession, U.S. consumers went on a spending binge. The proportion of after-tax income devoted to saving fell from more than 10% in the mid-1980s to close to zero by 2005—we spent every last penny of every last dollar earned.

During the same period, the amount that consumers owed on both consumer and mortgage credit soared—from 60% of after-tax income to more than 123%.

Both trends were unsustainable, and the sharp slowdown in consumer spending that resulted is one of many reasons the recent recession is termed “great.”

On top of the debt buildup, households received a double-whammy to net worth: falling home and stock prices. Household net worth plummeted by 20% in 2008, and although it has recovered somewhat with the rising stock market, total net worth at $58 trillion is still well below its 2007 peak of $64 trillion.

Net worth recovery has been greater for higher-wealth families—more of their assets are in stocks than in housing. For the many households with wealth concentrated in their homes, net worth remains depleted. The only way these families can restore net worth is the old-fashioned way: by saving.

All these factors explain why consumers as a group have been very tight with their purse strings lately—reducing spending to rebuild wealth and pay down debt.

The good news: In a quiet way, households have been surprisingly successful so far. The ratio of total debt outstanding to after-tax income has already fallen from 123% in first-quarter 2008 to 107% in first-quarter 2011.

This rapid decline was caused by:

  • A sharp reduction in discretionary loan demand from households able to borrow; and
  • Unavailability of credit to consumers whose credit scores suffered the most during the recession.

In addition, lenders have charged off a sizable amount of debt. Household indebtedness has a distance yet to fall. But it’s to the point that the ratio can fall gradually as long as moderate debt growth is less than income growth, which is quite likely.

As the amount of debt outstanding has declined, so too have monthly payment ratios—assisted by very low interest rates.

The overall ratio of debt payments to monthly income, after peaking at 14% in third-quarter 2007, has since fallen to 11.5%, a level not seen since 1995. At the same time, average credit scores are increasing.

Last year saw the first year-over-year decline in credit union loans outstanding since 1980, with total loans decreasing by 1.3%.

This year through May, loans are down slightly, but less so than last year. CUNA’s economists forecast loan growth of 2% this year and 5% next year. This isn’t roaring loan growth, but at least it’s moving in the right direction.

With improved balance sheets and debt ratios, members are now more able to take on some debt. But they need a trigger to be willing to borrow again.

If the recent pause in economic growth turns out to have been temporary (which is likely), the monthly employment numbers will begin to look better again, and unemployment will resume its decline.

That trend, combined with stable or falling gasoline prices and a stronger stock market, should provide a sufficient boost to consumer confidence to get things rolling again.

Not a boom, but a gradual strengthening of member loan demand—which will be welcome news for credit unions. 

BILL HAMPEL is CUNA’s senior vice president of research and policy analysis/chief economist. Contact him at 202-508-6760.