Message from the media has been that consumers are focused on reducing debt levels, and paying down existing balances. Do you believe in fairy Tales?

If you believe that and think positive thoughts,

your good vibes might save Tinkerbell,

because that story is a fairy tale.

By Chuck Jaffe
10/13/10
BOSTON (MarketWatch) — If the media doesn’t understand consumer delinquency numbers, there’s no reason to believe consumers get it. But what became patently obvious last week when the American Bankers Association released second-quarter data on the nation’s credit picture is that the “good credit behaviors” we keep hearing about of late are mostly hogwash.

It’s not entirely surprising. In a nation that has a deficit problem, where average consumers have at least minor debt troubles, there are going to be a lot of delusions and misconceptions about how credit works.

Consider how three news organizations covered the American Bankers Association release on Oct. 5. According to the Associated Press, “Delinquency rates for three key consumer-loan categories improved in the second quarter,” which was surprising to anyone who read the Bloomberg Business News report which said that “U.S. consumer-loan delinquencies increased for the first time in a year…amid a slowdown in recovery from the worst economic crisis since the Great Depression.”

MarketWatch, meanwhile, noted that “In a positive sign for the economy, the number of consumers who were delinquent on their loans fell in seven of 11 loan categories.”

In other words, the economic data was pointing in every direction, signifying nothing. It certainly does not mean what economists, politicians and most in the media are saying it means.

Do you believe in fairy tales?

The message from the media has been that consumers are focused on reducing debt levels, and paying down existing balances. They are using credit cards less, building their savings and being prudent with their spending. The Federal Reserve’s G-19 Consumer Credit Report showed that, as of July, revolving consumer debt had been on the decline for 23 straight months, a period of nearly two years.

If you believe that and think positive thoughts, your good vibes might save Tinkerbell, because that story is a fairy tale.

“Look at the charge-off numbers for the banks and they are almost dollar-for-dollar the decline in consumer debt,” said Greg McBride, senior financial analyst for Bankrate.com. “So you are getting headlines about how much better off consumers are, and how they are paying down their debts, but that’s not what’s really happening.”

It’s an economic sleight of hand that should feel pretty familiar. It’s akin to statistics showing that unemployment is going down, when the numbers exclude the chronically unemployed who have been out of work for so long that they drop out of the active work force. They’re not working, but the overall statistics look better with them on the outside.

That’s how it is on consumer-debt numbers too. There are two main ways for things to get better: either consumers pays down their bills or banks write off the worst garbage on their books.

A recent study by CardHub.com looking at the G-19 report and comparing it to bank charge-off numbers found that revolving debt was off by $12 billion in the second quarter of 2010, but that banks actually charged off some $21.8 billion in bad debt. What that means is that consumers actually accumulated debt—nearly $10 billion more than the year before—and the only progress was caused by banks giving up on consumers who are too far gone to pay.

CardHub’s latest projection is that consumers will accumulate an additional $26.2 billion in credit card debt this year, relative to 2009.

Lenders aren’t just writing off their bad, old debts, they’re tightening up on making new ones. As a result, the few consumers who really have taken the tough economy to heart and who have made strides on debt reduction and credit-score improvement have been met with tougher credit terms.

Tighter limits

Many credit-card issuers, for example, are “walking up the balance,” which means they are reducing a customer’s credit limit as the consumer pays off outstanding debt.

Say someone has a credit card with a $10,000 limit and holds the average household credit debt of roughly $9,000 on that card. They pay off $2,000 of that debt; their balance has shrunk to $7,000, but the card issuer—wanting to reduce its potential liabilities—might cut that borrower’s available limit down to $7,500.

In this case, the borrower is doing the right thing, but they have little to show for it. When they started this debt-reduction effort, they were using 90% of their available limit; the reduced credit limit means they finish their pay-off using 93% of the reduced balance. That puts them closer to the edge and likely means the consumer’s credit score will not improve, in spite of the fact that they have less total debt. Link to the rest of the fairy tale