Q&A of the Day – Are We Still Able to Afford our Bills?
Each day I feature a listener question sent by one of these methods.
Email: brianmudd@iheartmedia.com
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Today’s Entry: Hi Brian, love the show! Something I’ve not heard addressed with all of the banking concerns is consumer debt. The previous banking crisis was brought about by consumer debt failures led by housing. If delinquencies rise while the banking system is already stressed – that's when I’d think the financial system would see significant failures. My question for you is...are consumer delinquencies rising?
Bottom Line: Great points – all of them. The current brewing banking crisis has largely been brought about by asset bubbles specific commercial banks were leveraged to. Asset bubbles which were created by unprecedented levels of federal government spending and subsequent money printing in the name of the virus. That’s opposed to a housing bubble as was the case during the 2008 financial crisis which you mentioned. Your point is on point about consumer concerns. If we already have a compromised banking system, independent of consumer defaults, what would happen if they started to mount? We’ve had 21 consecutive months in which the rate of inflation has risen faster than wages and of course there’s only so long that can continue before the average consumer simply can’t afford the cost of everyday life any longer. So, are we there yet? Let’s dive in.
A quick search of the topic right now will net you headlines like this one from NBC a few days ago which reads: Shrinking savings and rising debt leave consumers on shaky financial footing. If the headline sounds ominous, the sub headline sounds worse as it reads...The events drew parallels to the 2008 financial crisis and are likely to cause banks to tighten up their lending, putting added pressure on already strained consumers. Well, that’s fun. So, what’s actually been happening with consumer debt and how does it compare to 15 years ago? There are three key categories to keep an eye on. Mortgages, auto loans and credit cards. Those three are specifically key because they speak to the human condition when one is faced with difficult financial decisions. Historically, during times of financial distress when someone is struggling to pay the bills, there’s a prioritization to it. The bill that’s the most likely of those three to be paid is the car loan, because it’s viewed as essential and it’s lower in cost than the mortgage. Credit cards are next, because while they’re the least vital of the three, the cost of meeting a monthly minimum is much lower than that of a mortgage payment for most. That leaves mortgages as the least likely of the three to be paid. So, what do the delinquency rates in these big three categories look like today?
- Auto loans: 1.9% (highest since 2006)
- Credit Cards: 2.3% (up from 1.6% year over year)
- Mortgages: 4% (up from 3.4% in the prior quarter)
True to form current delinquency rates are in order of what we’d expect in any economy. From there the not-so-good news is obvious. They’re all rising. But there’s a difference between rising rates and problematic rates. So, if we’re having conversations about whether we’re on the brink of what happened during the 2008 financial crisis. Let’s compare where those rates are today with where they were in March of 2008.
In this comparison the good news is obvious. Both credit card and mortgage default rates are less than half of what they were just prior to the bottom starting to fall out of the economy in the 2008 financial crisis. At the same time the news isn’t all good because auto loan default rates are 70% higher today than they were then. What does this seemingly mean? Given that auto loans are the best sign of severe financial distress, the higher rates of default with those loans suggests there’s a larger base of people in severe financial distress today than there were 15 years ago today. At the same time, with default rates far lower on the other layers of the onion, it suggests the financial distress is fairly isolated and hasn’t, at least yet, become a systemic issue. What would have to change for that to be the case? There are three potential catalysts.
- Inflation continuing to rise faster than wages for an extended period of time from here
- Significant jobs losses / rising unemployment rate
- Home price depreciation resulting in underwater mortgages
Those three are pretty self-explanatory but to elaborate on the third... The housing market peaked in May of 2006, yet the full effect of the housing crisis wasn’t felt within the financial sector until the fall of 2008. The reason it took so long for the housing crisis to play out was that even with many Americans no longer able to afford their mortgages (or perhaps never having been able in the first place), most were able to sell their homes due to price appreciation over when they purchased them as opposed to having them foreclosed on. The crisis hit when depreciation no longer made that possible. So that’s where we are and that’s what to watch for – independent of the commercial banking crisis which has already been playing out.