Academic journal article Journal of Legal, Ethical and Regulatory Issues

Consumer Credit: The Next Shoe to Drop or a Bullet Dodged?

Academic journal article Journal of Legal, Ethical and Regulatory Issues

Consumer Credit: The Next Shoe to Drop or a Bullet Dodged?

Article excerpt

INTRODUCTION

The amount of consumer credit outstanding has increased substantially over the last 30 years as American consumers have increased their use of credit. According to the Federal Reserve Board, consumer credit outstanding increased more than eight-fold from $310 billion in January 1979 to $2,592 billion in December 2008.

Figure 2 shows that consumer credit is held by several different types of financial institutions and businesses, as well as sold to investors in securitized issuances. Commercial banks are the largest holders of consumer credit, with $878.6 billion or 34% of consumer credit outstanding at the end of 2008. The second largest amount of consumer credit outstanding is held as pools of securitized assets, with $650.0 billion or 25% of consumer credit outstanding held by investors. Finance companies follow with $575.8 billion or 22% of consumer credit outstanding. The remaining 19% of consumer credit outstanding is held by credit unions (9%), student loans (4%), savings institutions (4%), and nonfinancial businesses (2%). This research examines consumer credit outstanding and considers the benefits and risks to the various market participants in light of the financial crisis, as well as the implications of recent changes in policy and regulation regarding consumer credit and financial institutions.

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SECURITIZATION OF CONSUMER CREDIT

The large increase in consumer credit outstanding has been facilitated by the securitization of consumer credit. In 1985, auto loans were the first type of consumer credit to be securitized when Solomon Brothers sold $60 million of securities backed by auto loans that were originated by Marine Midland Bank (Greenbaum and Thakor, 2007 pg. 360). The securities were known as Certificates of Automobile Receivables (CARs). The following year, Solomon Brothers continued innovating by purchasing $50 million in credit card receivables from Banc One and selling Certificates for Amortizing Revolving Debts (CARDs) that were backed by the credit card receivables. Securitization of consumer credit has proliferated over the subsequent years.

Securitization of consumer credit has benefited both lenders and borrowers. When consumer loans and other types of consumer credit are removed from the asset side of the balance sheet through securitization, financial institutions are relieved of the burden of maintaining sufficient capital relative to the assets thus removed. As a result of the liquidity provided to financial institutions through securitization, credit has been more readily available to American consumers. Securitization has also provided additional investment options for the investment community. The percentage of consumer credit that is securitized grew rapidly over the years until the late 1990s and reached its peak in June 2002 with 31.8% of total consumer credit outstanding securitized. The growth in the securitization of consumer credit coincides with the explosion of mortgage securitization noted by Wegman (2008). Since then, the percentage of consumer credit that is securitized has fallen to 25.2% in June 2009. The financial securities that are created through securitization are generally referred to as asset backed securities (ABS).

The types of consumer credit that are most commonly securitized are home equity loans and lines of credit, credit card receivables, auto loans, and student loans. Figure 4 shows the growth in the various types of securitized consumer credit over time. In 2004, the amount of securitized home equity loans (HELs) and home equity lines of credit (HELOCs) outstanding surpassed that of securitized credit card receivables, as consumers borrowed against the rising values of their homes. HELs and HELOCs now constitute the largest portion of securitized consumer debt, with $395.5 billion outstanding at the end of 2008. Both HELs and HELOCs offer the advantage to borrowers that interest on the loan is generally tax deductible. …

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