Sharon

Yesterday put the nail in the coffin of a move from recession (small “r”) to Depression (capital “D). Two pieces of news that were absolutely essential came out – and no, neither one was that we’ve been in a recession since last year, or that last week’s stock market rally was yet another sucker rally. The first was the observation that McDonalds is now the second-largest merchant vendor on credit cards – that is, people are now buying their Big Macs on plastic – in part because they don’t have the cash. Credit card balances have risen enormously in the last few weeks, as people attempt to keep going through the holidays:

Commercial bank exposure via the total amount of credit card loans outstanding has risen more in the last 10 weeks than it did in the previous 10 months cobined. Moreover, the growth in the last 10 weeks — $32.3 billion, or roughly $600 million per shopping day — represents nominal growth of 9.3%, or 48.3% annualized over the last 10 weeks. According to American Express, delinquencies on credit payments rose to 4.1% of all credit outstanding in the third quarter, up from 2.5% in 2007, with Bank of America’s rate rising even more steeply – to 5.9% for the period. Moreover, the pool of loans deemed uncollectable rose to a high 6.7% in the third quarter, soaring from 3.6% last September. What consumer spending there is has been fueled in part by credit card: The second-largest merchant-vendor for credit card use is now McDonalds. This suggests that many consumers are in serious distress if they need to get their $4 Big Mac and fries with a credit card.



The second is the news that credit card companies are planning to pull 2 trillion dollars of personal and small business credit lines over the coming months, to reduce their risk:

The credit card is the second key source of consumer liquidity, the first being jobs, the Oppenheimer & Co analyst noted.

“In other words, we expect available consumer liquidity in the form of credit-card lines to decline by 45 percent.”

Almost all of the consumer spending we’ve done in the last few days has been done on credit. In November and December, retailers see more than 40% of their annual sales – and since the average American comes out of the holiday season with more than $800 in credit card debt, it is safe to say that retailers in general are dependent on an annual payback that is then amortized over mos tof the year in the form of personal credit. That is, the consumer spending economy, 70% of our total economic activity, is utterly dependent on consumer credit. And whether that’s a good thing or not, the destruction of consumer credit lines will bring about a shift in consumer spending that makes the present economic woes looks petty.

But there’s more to it than that – Americans have seen real wages decline, and have depended heavily on credit, and as unemployment rises and companies cut benefits, pensions and retirement savings disappear, they will depend on their credit more, not less. The credit card allows them to even out uneven income streams – and millions of Americans have them. Either they rely on uneven overtime, on tips, on seasonal boom and bust cycles, or as small business owners and contractors whose payment comes in irregularly.

When unemployment strikes, right or wrong, the expenses go on the credit card. When hours are cut back or paycuts proposed, the credit card covers the inevitable emergency car repairs or medical bills. Yes, people should have saved. Yes, running up credit card debt you aren’t certain you will be able to pay off is dangerous. But it is also the case that saving has been enormously discouraged, and reliance on credit has become a cultural norm, even a cultural pressure. Cards poured out like water. Couples who arrived with a downpayment at a mortgage meeting were told to keep their cash and take out a 100% loan. Companies made huge sums of money by persuading ordinary people to put their money in the markets and that growth could never end. Yes, there is personal responsibility here, but the situation was not of each person’s personal making, and there is plenty of blame to go around.

In difficult times, the American policy is to rely on credit as a reserve source, as a substitute for savings. And that reserve is about to be pulled out from under them. And for the best reasons – the ability to pay is declining rapidly. Most Americans have no idea how they would pay off their debt in this economy – and my bet is that most of them won’t. Past recessions have been survived by increasing debt and sitting tight until things got better. Now, we can’t increase debt, and we can’t sit tight, and it will be a long time before things get better – much longer than most people forsee. You only have to look at the bank’s own reasoning here – they are withdrawing their credit lines because they don’t believe that a boom will come along and allow people to pay off before they are forced to default. They know that reducing credit on this scale will hurt them too – but their own internal analyses have convinced them that they are in more danger by loaning than they are by not loaning. Given the huge role of consumer credit in the economy, that’s one big shift.

What is certain is that without credit, the recession will hit a lot harder, a lot faster than it has. Personal spending will drop a whole lot more. People who were getting at least Big Macs will stop having them to eat. Moreover, with reduced credit lines, people will be forced rapidly to assess their situation – the transition between unemployment and foreclosure, between a bad year and homelessness, between getting by and going hungry, between surviving a medical crisis and being bankrupted by it – will be much, much shorter.

Yes, building up credit card debt has been bad for us. But it has also functioned to delay our reckoning, to keep marginal participants in the economy going, to keep the economy going even as far as it has been. And without large open credit lines, life as we know it will shift. Suddenly, small businesses won’t be able to buy inventory on credit – and many of those businesses will close. Travellers whose balances are near their new, dramatically lowered limit will not travel, because they can’t reserve a car, a hotel room or a plane ticket. People will stop shopping online. And the kids whose daily meal, tragically enough, was the Big Mac (and we should remember that one out of every three Americans eats daily in a fast food restaurant) won’t eat.

Sharon