Record Plunge in U.S. Consumer Credit Signals Weakened Spending

By Bob Willis and Vincent Del Giudice

Sept. 9 (Bloomberg) -- A record $21.6 billion drop in borrowing by Americans added to evidence that consumer spending will be slow to recover as banks and credit-card companies tighten lending standards and households pay down debt.

Consumer credit fell by 10 percent at an annual rate in July to $2.5 trillion, according to a Federal Reserve report released yesterday in Washington. The drop was more than five times larger than economists forecast. Credit fell for a sixth month, the longest series of declines since 1991.

“The consumer is hunkered down in the process of repairing his finances,” said Ryan Sweet, a senior economist at Moody’s Economy.com in West Chester, Pennsylvania. “Consumers remain very cautious and won’t be leading us out of this recession.”

Unemployment that’s projected to reach 10 percent by early next year and a decline in household wealth are casting doubt on the strength of the recovery from the worst economic slump since the 1930s. Federal Reserve policy makers, at their last meeting in August, expressed “uncertainty” about the projected pace of gains in spending by households.

The start of the government’s “cash for clunkers” program in late July wasn’t enough to keep credit that covers car loans from plummeting by a record amount, yesterday’s Fed report showed.

Non-revolving debt, including loans for automobiles and mobile homes, plunged by $15.4 billion in July. The Fed’s report doesn’t cover borrowing secured by real estate. Revolving debt, such as credit cards, fell by $6.1 billion.

‘Short-Term Benefit’

Non-revolving credit may have picked up last month as the auto rebate program boosted vehicle sales. The program, which ended in late August, pushed auto sales for the month to a 14.1 million annualized pace, the highest since May 2008.

“There were some car purchases and we will see some short-term benefit” from the program, said Guy LeBas, chief economist at Janney Montgomery Scott LLC in Philadelphia. “But one month is not enough to make the year.”

Economists had forecast consumer credit would drop $4 billion in July, according to the median of 31 estimates in a Bloomberg News survey. Projections ranged from declines of $12 billion to no change from the previous month.

Revolving credit may shrink by another 20 percent by the end of next year as banks pare credit lines further and more consumers turn to debit cards to pay their bills, said FBR Capital Markets Inc. analyst Scott Valentin.

U.S. banks tightened standards on all types of loans in the second quarter and said they expected to maintain strict criteria on lending until at least the second half of 2010, a Federal Reserve report showed on Aug. 17.

‘Uncertain’ Outlook

Most banks cited reduced risk tolerance and “a more uncertain economic outlook” as the main reasons for restricting credit to businesses, with 35.2 percent saying they “tightened somewhat,” the Fed said in its quarterly Senior Loan Officer survey.

The central bank lowered its main rate almost to zero in December and committed to purchasing as much as $1.75 trillion of Treasuries and housing debt to reduce borrowing costs.

Consumer spending growth will average almost 1.5 percent in the second half of this year, according to a Bloomberg News survey of economists conducted in the first week of August, after falling by an average 0.2 percent in the first half. They also forecast the jobless rate would average 10 percent in the first quarter of next year.

Economists in the survey didn’t see annual growth in consumer spending topping 2 percent until 2011, even as they forecast the economy to return to growth in the second half of this year.

Range of Views

Fed policy makers “expected the pace of recovery to pick up in 2010, but they expressed a range of views, and considerable uncertainty, about the likely strength of the upturn -- particularly about the pace of projected gains in consumer spending and the extent to which credit conditions would normalize,” according to minutes of their Aug. 11-12 meeting released last week.

Plunging home values and stock prices have fueled a record $13.9 trillion loss in household wealth in the U.S. since the middle of 2007.

A Labor Department report last week showed payrolls in August fell the least in a year. At the same time, the jobless rate rose to the highest in 26 years, a reminder that hiring will take longer to rebound, restraining consumer spending.

The economy has lost 6.9 million jobs since the recession began in December 2007, the biggest drop in any post-World War II economic downturn.

Consumer spending rose 0.2 percent in July, following a 0.6 percent increase in June, government data showed on Aug. 28. Excluding cars, purchases were little changed.

Incomes were unchanged in July after dropping 1.1 percent in the prior month. The decrease in income in June reflected the fading boost from government stimulus-related tax cuts and transfers. Wages and salaries posted the first gain of the year in July, increasing 0.1 percent after dropping 0.3 percent.

To contact the reporter on this story: Vincent Del Giudice in Washington vdelgiudice@bloomberg.netBob Willis in Washington bwillis@bloomberg.net