Coming out of the Great Recession, the last thing anyone wants is for financial history to repeat itself. However, when it comes to consumer debt, that is exactly what’s happening. Many people think that overall credit card debt is decreasing just because consumers paid down over $43 billion in debt during the first quarter of 2010. However, this is merely a reflection of what occurred in the same quarter last year. Numbers from the second and third quarters of 2010 show that—like in 2009—consumer debt is actually rising and is on track to wipe out most of the reduction observed in Q1.
According to the Q3 2010 Credit Card Debt Study conducted by CardHub.com, consumer credit card debt increased by almost $6.5 billion in the third quarter of 2010 alone.
So how did Card Hub come to the conclusion that credit card debt is really rising, when the contrary is being so widely reported? Because many people are taking the wrong approach to measuring this debt. When evaluating consumer credit card debt, many market analysts look only at surface changes in outstanding credit card debt levels. However, considering outstanding debt in a vacuum is misleading because credit card charge-offs must also be factored in.
Credit card companies are required to charge-off debt that is 180 days delinquent. When debt is charged off it does not disappear, credit card companies merely have to take it off their books. This debt is still very real for consumers because it stays on their credit reports for 7 years and credit card companies will continue attempts to recoup it, either directly or through collection agencies. So failing to account for charged-off debt leads to distorted overall numbers because it is essentially like pretending that some of the most serious credit card debt that consumer have merely does not exist.
At the end of Q2 2010, there was $800.3 billion in outstanding consumer credit card debt. This amount decreased by roughly $10.3 billion during Q3 2010, but credit card issuers also charged-off almost $16.8 billion during this same period. This $16.8 billion amount did not vanish, however; companies simply no longer counted it because it was written off. Therefore, the actual existing debt is the outstanding debt ($790 billion) plus the charged-off debt ($16.8 billion), or $806.8 billion total. So what may appear on the surface as a $10.3 billion drop in debt was really a $6.8 billion increase when charged-off debt is factored in.
So what do these figures mean, and why has consumer debt decreased in the first quarters of both 2009 and ’10 before increasing throughout the remainder of the year?
Well, for starters, a large credit card debt reduction is typical in the first quarter of a year because many people receive bonuses and tax refunds and make a conscious effort to alleviate their holiday spending debt during this time. Additionally, these numbers show that in Q2 and Q3 of 2010, consumers increased their debt by 11% more than during the same period last year. This relative increase is indicative of people feeling optimistic about the state of the economy and reverting spending back to pre-recession levels. As a result, I worry that the large segment of consumers whose income or spending was tied to the housing bubble have not fully internalized the fact that even when the Recession ends, spending cannot relapse. Yes, paring down expenditures is difficult because it requires learning to live without things to which we have become accustomed. But hopefully we will all manage to adjust how we classify luxuries and necessities anyway so we can emerge from the recession free from the burden of
Disclosure: Some of the links within this article point to CardHub.com, which is owned by the same parent company as Wallet Blog.