Magazine article The Journal of Lending & Credit Risk Management

The Economy Looks Good, but Watch Out

Magazine article The Journal of Lending & Credit Risk Management

The Economy Looks Good, but Watch Out

Article excerpt

The toughest job that economists have had recently is to come up with the next best adjective to describe what is going on. Indeed, by almost any measure, conditions are fabulous. Because of strong growth, the jobless rate - 4.5% - is at a generational low. However, it is clear that the growth of the economy is slowing and will slow significantly through the remainder of this year and into 1999. We will experience slower growth, but steady, healthy growth nonetheless. Despite growth and low unemployment, inflation is nonexistent. Consumer Price Inflation is below 2% and continues to decelerate.

Leading the charge for the economy is the consumer. Ecstatic about the strong job and income growth, the surging stock market, accelerating house values, and rising homeowner's equity, consumer confidence is at a record high. Consumers are buying everything from apparel to vehicles. Nowhere is that more evident than in the housing market. New and existing home sales will be close to 5.5 million units this year, an all-time record high. In addition, home building is soaring - in the past five years, more single-family homes were built than in the late 1970s when the baby boomers were forming households. House prices are rising at a strong pace, with nominal growth at 6% per year. That means that real house price growth is about 4%, the strongest house price growth since the 1970s.

One of the encouraging aspects of the consumer boom is that it is not being financed with debt. In fact, it's being financed purely by income gains. Debt growth is slowing significantly, particularly for consumer credit. See Figure 1, which shows the year-over-year growth of consumer credit.

Why Is Credit Quality Deteriorating?

Mortgage debt growth is accelerating at about 8% year over year, the strongest since the early 1990s. There is some substitution of consumer installment debt for mortgage debt, but when total household debt is added up, the growth now is comparable with the growth in disposable income. That means household debt burdens, the portion of after-tax income devoted to paying principal and interest on consumer installment and mortgage debt, has leveled off. It's no longer rising and stands at about 17% of income. That's relatively high and well above what it was just a few years ago. This is clearly a reason why there has been a deterioration in the credit quality of consumer loans in the past several years.

Who's Got the Debt Burden?

The encouraging news is that the debt burdens are now much more level and the prospects are that they will actually begin to fall. One of the most significant positive aspects of the Asian economic crisis is its affect on the bond market. Lower interest rates have caused the mortgage refinancing boom to reach unprecedented levels. It is helping to contribute to a lowering of debt service burdens for households, even though they may be adding to their mortgage balances when they refinance, but this is a positive development for the consumer sector, at least in the near term.

The reason debt growth is slowing is partly related to a greater reluctance on the part of consumers to take on debt. Some have been burned by delinquencies and bankruptcies and are probably less grilling to take on debt. More than likely, it has do with the fact that the economy has been so good and incomes so strong that that consumers have been able to finance their consumption out of current income.

Lenders also have contributed to the slowing of debt growth (see Figure 2). Consumer lenders have clearly tightened their loan standards. Since early 1996, lenders have been much more reluctant to extend credit. Their loan standards have been tightened considerably, particularly for credit card lenders. Broader statistics measuring consumer credit quality, available in weekly surveys conducted by Visa and MasterCard, show that there has been a peak or a near-peak in bankruptcy filings and delinquency rates. …

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