Wednesday, December 1, 2010

The New Meaning of Credit

Lending and borrowing continue to decline.

  • Loans are harder to get. In reports to regulators, banks say they’ve tightened their underwriting since June. At the same time, banks say customers aren’t seeking to borrow as much or as often as they were earlier in the year.
  • People are borrowing less. According to the New York Fed, total household debt fell again in the 3rd quarter. Household debt has fallen to levels not seen since 2006. It is 7 percent below its 2007 peak.
  • People are using their credit cards less, and even canceling them. The number of consumers with credit cards declined by an estimated 8 million this year. That’s a number that previously had only gone up from year to year. The amount of credit card debt has declined by about one eighth. Credit card debt jumped up at the beginning of the recession, then fell off as consumers became more cautious, but no one in the credit card industry would have imagined this kind of decline even last year.
  • Mortgage applications, which picked up modestly with October’s low interest rates, are falling off with interest rates moving up again.
  • Savings rates have increased from near zero (at mid decade) to about 6 percent. That is still a low level, and the United States promised the G-20 that it would increase its savings rate. Saving can be seen as the opposite of borrowing, as paying off debts is included in saving in economic statistics.

It seems to me that these are signs of a lasting cultural change in the meaning of credit. For a quarter century, many consumer and business decisions were based on the assumption, “You can always get a new loan.” This allowed businesses to proceed with risky and often reckless business plans, with the idea that more money could be borrowed whenever something went wrong. Suze Orman, on her television show, advised people planning their personal finances that they might be able to use a line of credit to cover emergency expenses. That thinking changed around 2007. Business plans now have to be written with an exit plan, and Suze Orman has been cautioning viewers that if a financial emergency comes up, a credit card account or other line of credit might vanish.

At the same time, Apple has grown to be one of the largest businesses in the world with a policy of not borrowing money, while its deep-in-debt competitors stumbled (or disappeared, as most of them have done). In the past, business people scoffed at Apple’s cautious approach to building its business, but now that it is a blue chip stock, it is more likely to be studied and imitated.

In the last four years or so, a person or company that is deep in debt is no longer optimistically described as “high-flying.” Instead, they are “down on their luck,” or “at the mercy of their creditors” — not a position anyone would choose to be in. A more cautious approach associated with an absence of debt is no longer vaguely scandalous, but is now seen as “lucky.”

I think there are two main ideas that are behind the new meaning of credit.

  1. Time pressure. People are under increasing time pressure, and are more aware than before of the time costs that come with borrowing money, and the tight cash management that goes along with this.
  2. Control. For a time, easy access to credit gave people the illusion of being in control of their finances. That illusion is fading, and people are looking to patterns like positive cash flow, paying in cash, and money in the bank as replacements.