Legal Commentary

CardHub Study says Decline in Credit Card Debt a Result of Chargeoffs, Not Frugality:

By Todd Zywicki

A spreading meme is that there is a new frugality among consumers, as evidenced by a decline in credit card balances outstanding over the past several quarters.  An interesting new analysis by CardHub, however, argues that this is a measurement error: that the decline in outstanding balances is actually a result of increased chargeoffs of debt, not consumers paying down debt.  In the aggregate a chargeoff or a payoff both count as retiring the debt.

CardHub further says that once chargeoffs are removed, credit card actually increased by 9 billion dollars last quarter.

If this is correct, then it resolves for me something that has always struck as being potentially a bit anomalous (although not necessarily so): one theory of consumer credit is that credit use should actually rise during a recession, as consumers would be expected to use credit as a consumption smoothing device.  Yet it is not uncommon for outstanding consumer credit to decline during a recession.  One possible explanation for this is that there is also a supply adjustment?lenders offset any increased demand by reducing credit lines because of increased risk.  Another possible explanation is that consumer demand for credit is actually pro-cyclical, rather than counter-cyclical.  A third is that suggested by CardHub, which is that it is primarily a measurement phenomenon, rather than a real phenomenon.

Something similar is at work in the much-ballyhooed observation that an increased personal savings rate is evidence of increased consumer frugality.  That, it turns out, is almost entirely a function of the peculiar way in which ?savings? is measured, and most importantly its exclusion of increases in wealth in the nature of capital gains and the way it treats taxes.  I?ve discussed that in detail in one of my articles here.  Recent increases in the measured savings rate are almost certainly no more than a reflection of the massive destruction of household wealth brought about by the housing crisis and the large declines in the stock market.  That decline in wealth, it should be noted, would also likely percolate through in the form of reduced consumer credit use as consumers scale back their use of credit as a device for liquifying their wealth.  Which would be consistent with the hypothesis that consumer credit use is pro-cyclical rather than counter-cyclical.

What does all of this mean?  It is premature to assume that declining credit card balances and a rising savings rates evidence a change in consumer preferences and a ?new frugality? afoot in the land.  Instead, it may be simply that preferences have remained constant but household budget constraints have changed and consumers have rationally responded to changes in the elements of their household wealth and borrowing portfolios.

Also, many of the measurements that are traditionally used to assess this are terribly flawed and in many cases absolutely misleading.

Full post as published by The Volokh Conspiracy on September 14, 2010 (boomark / email).