Perspectives

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Household Debt Explosion

It looks like consumers are borrowing more money than ever, and many articles lately would have you believe overall that’s a good thing: it’s happening for the right reasons, and it is a true sign that the economy is certainly on the mend. Consumer confidence is back! However, the truth sounds something more like we have quite a way to go yet. Don’t get caught napping.


In early August, the Federal Reserve reported a record increase in US household debt, which rose by its highest dollar amount in 14 years, reaching almost $15 trillion. As CNBC reported, “total debt balances jumped $313 billion in the April-to-June period, the sharpest rise since the same period in 2007”.


As could be expected, most of the new debt originated from new mortgages, incentivized by the rock-bottom interest rate environment. However, a much more worrying development was the significant increase of credit card debt that had previously been mostly in decline since the start of 2020. Supporting this trend is the fact that the number of credit inquiries in the past six months also increased by 3.7% to $121 million.

The state of the real economy


This surge in borrowing might seem surprising at first glance, given the prevailing “Great Recovery” narrative that is promoted by political leaders and the media. According to them, the covid crisis is already over and the economy is back on track, with robust growth just around the corner. To support their case, they point to stock markets reaching new highs and investor’s risk appetite returning to pre-pandemic levels. Clearly, they conclude, the record-shattering stimulus spending and the aggressive monetary expansion saved the day once again, and thanks to the political leadership and central bank support, we’re all going back “business as usual”.


And yet, the reality on the ground, as revealed by rising consumer debt levels, debt default data, and similar figures that focus on the state of household finances appears to be very different from the rosy picture presented by US government officials and mainstream media reports. Despite the trillions of dollars spent on covid relief checks and other subsidies, the fact is that there are millions of Americans still struggling to make ends meet, pay their bills, and even put food on the table.


The marked rise in credit card debt is being used by some analysts and pundits as evidence of consumer confidence coming back, however, this argument is highly misleading. The truth is that a great chunk of this debt is actually being used to pay down preexisting debt, and the worst kind there is, namely payday loans and other high-interest and predatory consumer finance products.


As might be expected, the segment of the population that is suffering the most are those at the lowest income levels, people from marginalized communities and disadvantaged areas. As Bloomberg reported, according to data collected by the Federal Reserve Bank of New York, “U.S. households had used or planned to use about a third of the cash they received via stimulus checks to pay down debt. For families earning less than $40,000 a year or without a college degree, the share was closer to 40%.”


Winners and losers


While the covid crisis and the government’s handling of it might have brought countless Americans to the brink of financial collapse, it proved to be a great time for high-cost and predatory lenders. For instance, Enova International Inc. and Elevate Credit Inc., two listed companies that cater to borrowers with poor credit scores and provide loans at exorbitant rates, reported record profits in 2020.


Companies in this industry have been frequently criticized for unethical business practices and exploitative terms, including offering loans at annualized rates that can run as high as 589%, as well as various fees and hidden charges that often trap borrowers into a never-ending debt spiral.


What’s more, they are also known for specifically targeting underprivileged communities and people of color in their advertising campaigns, as researchers at the University of Houston confirmed in a recent study. The overwhelming majority of households that do find themselves in this vicious debt cycle are Black and Latino, a persistent and growing trend that widens the racial wealth gap, one of the main socioeconomic issues that the current administration has vowed to tackle.


And there’s no reason to expect this trend will be reversed anytime soon. In fact, it looks set to gain more traction, as demand for high-cost loans is anticipated to grow even more in the coming years. According to latest New York Fed survey of consumer expectations, US households expect to increase their spending by 4.6% over the next year and a significant part of this spending will be financed by fresh credit. In addition, demand for loans is also expected to be driven by the countless small business owners that were devastated by the lockdowns and are still struggling to survive.


Payday lenders are already gearing up to meet this fresh demand. For instance, last year Enova acquired OnDeck, a company that offers small business loans that have an average interest rate of 49%, in order to target the businesses hardest hit by the forced shutdowns, like salons, small local retailers and gyms. As the company’s CEO put it during a call with Wall Street analysts in April, “many of these businesses have used up their savings trying to survive the pandemic. This could lead to a large surge in demand that we are ready to fill.”


Once again, the devil is in the details when it comes to the “Great Recovery” narrative vs. the reality. There is certainly a danger in forgetting the problems being created for the economy while simply assuming everything is going in the right direction. And it’s usually those problems that set up the next financial crisis.


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