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Last week, I cited a Federal Reserve report showing that credit card use has been falling steadily since mid-2008, and suggested that Americans might finally be "getting the message" about credit card debt.
I wrote that article after looking at a bunch of data suggesting that Americans have been "deleveraging," using their resources to pay down debt instead of spending more. That seemed like a great trend, one worth taking a closer look at.
But there's a problem: Upon closer examination, there's very little "deleveraging" going on. That disappearing debt load turns out to be made up mostly of defaults.
So much for a smarter America
As a Wall Street Journal report pointed out yesterday, there are two ways in which debt can decline: It can get paid off, or it can go unpaid to the point where the lender charges it off. Over the two years since June 2008, the total value of home-mortgage and consumer debt fell by about $610 billion. But the Journal's analysis of new data from the Federal Reserve suggests about a $588 billion reduction came from charge-offs.
The high level of charge-offs isn't exactly a new revelation, as Fool Morgan Housel has been on this story for a while. But it is sobering to consider the ultimate statistic: The household debt decline that can be attributed to the kind of financial discipline we've been hoping to see is trivial -- an annualized rate of decline of 0.08%.
And we're not done yet
Now to be sure, the worst of this is probably behind us. When charge-offs and delinquencies at JPMorgan Chase (NYSE: JPM ) , Citigroup (NYSE: C ) , and Bank of America (NYSE: BAC ) fell in the second quarter, it was reasonable to conclude that the nastiest debt had been purged from the system. Things appeared to be stabilizing, albeit at a high rate. Overall charge-offs were at 10.66% in the second quarter, according to the Federal Reserve, well above the 3%-4% that was typical before the economic crisis.
But a report last week suggested that there might be more pain to come, as several credit card issuers saw their charge-off rates rise in August. Capital One (NYSE: COF ) reported its first increase since March, charging off 8.19% of balances. Likewise, Discover Financial (NYSE: DFS ) saw its first increase since May, and American Express (NYSE: AXP ) , which has had a much lower charge-off rate than other big issuers, saw write-offs hold steady at 5.5% in August, after months of decline.
Clearly, people still aren't getting the message.
Don't play this game
Carrying a credit card balance has never been a great idea, but even financially prudent folks sometimes end up with a big balance during tough times. But this data suggests that the forces constraining consumer spending have more to do with increased discipline from the banks than with financial prudence on the part of consumers.
But cultivating that financial prudence is critical, especially when it comes to credit cards:
- Banks are not your friends. The Credit Card Reform Act outlawed several of the banks' favorite tricks for maximizing the amount of money taken out of your pockets, but credit cards are big business, and already the banks have come up with new ways to preserve those revenue streams. Those ways, shall we say, do not work to consumers' advantage. Don't play their game.
- Balances are wealth-busters. A credit card balance is a money sink -- even if you're not buying anything new, you're still paying, every month. The money going toward those payments could be used for stuff you need, stuff you want, or -- better yet -- building your wealth over time.
Long story short, if you have a credit card balance, it's worth doing all you can to get rid of it -- while credit cards have their place in an era when home equity may have disappeared and emergency funds may be thin, running a big balance is an expense you really can't afford.
Is the banks' newfound lending prudence holding up the recovery? Fool Morgan Housel says it's time to stop blaming the banks for the terrible economy.