Slowing Economy Brings Payment Problems

Consumers and their spending kept the economy moving forward for the past 12 months, despite sharp declines in business investment spending. It turns out that much of the strength in spending was financed through greater borrowing. The savings rate has fallen from 9 percent in 1992 to -1 percent in the first quarter of 2001. Now that debt service costs have reached near-record levels and unemployment has begun to rise, consumers are pulling back and creditors are beginning to share consumers' pain.

Economists David Wyss and Joseph Sheridan offer the following observations about the economic outlook and prospects for creditors (full text available at www.standardandpoors.com).

• American consumers have amassed the largest amount of debt (including mortgage debt) in history. The average household owes 107 percent of after-tax income. By itself this is not especially alarming, but debt service costs (ratio of monthly payments to monthly income) have risen back above 14 percent of income, about equal to the all-time high reached in 1986. The rise in debt service costs has come despite falling interest rates.

• Standard & Poor's (S&P) expects the U.S. economy will avoid a recession—barely. The federal tax cut should provide some boost to spending in the second half of 2001. However, unemployment will continue to rise (initial claims for unemployment insurance have reached their highest level since the 1990-91 recession) and S&P expects chargeoffs to continue to climb through 2002.

• As the Fed has worked to drive down interest rates (six cuts since January 3, 2001, for a total of 275 basis points), funding costs have fallen for credit card issuers. So far, this has offset much of the damage from rising loss rates stemming from escalating bankruptcies and chargeoffs.

• Consumer confidence appears to have stabilized. With this fall's boost from the tax rebate checks, consumer spending will continue to grow. Credit card transactions should grow as well since consumers are turning increasingly to plastic as their preferred payment device. In 2000, 33 percent of all consumer purchases were made with credit cards, compared to only 3.3 percent 20 years earlier.

• Bankruptcies are running 20 percent higher than a year ago. Accordingly, S&P expects chargeoffs in the S&P pools of securitized credit card receivables to rise from a rate of 5.6 percent of average outstandings in 2000 to 6.6 percent in 2001 and 6.9 percent in 2002. Further declines in short-term interest rates should cushion the impact of rising losses on the yields for credit card backed securities. However, portfolios with greater exposure to subprime collateral will be hardest hit over the coming year.

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