Consumers Are Too Giddy When It Comes to Borrowing

(Bloomberg View) -- Is there such a thing as being too happy?

Ronald Reagan was president the last time Americans were as overwhelmingly optimistic about the prospects for jobs. The latest University of Michigan survey on households’ expectations for unemployment declines in the next 12 months came in at 33 percent, matching January for the highest level since 1984, when it was 35 percent. What could be wrong with that?

History tells us that bubbles in optimism can be dangerous for the economy. For starters, an unemployment rate with a “three-handle” that is implied by the Michigan survey isn’t even in the same zip code as the Federal Reserve’s forecast for this year or next. The bottom of its 2018 range is 4.2 percent. Any notion of a gradual path of interest-rate increases would be dashed. The result would likely be an inversion of the yield curve -- which has historically preceded recessions -- and a weaker stock market.

The hard data have for some time been broadcasting what’s to come. The costs of higher education, housing and car prices have risen so much that households have had to stretch to qualify for a mortgage or make payments that are in line with the size of their paychecks.

While it’s true that “only” 11.1 percent of the $1.4 trillion in outstanding student loans are delinquent, as has been the case for four years running, fewer than half of all undergraduates are paying down their debt. The remaining are either delinquent or have asked for relief in one of two forms: temporary payment deferment or a payment plan gauged off their income level. A recent report from Goldman Sachs Group Inc. noted that, “high delinquencies will continue to constrain the ability of young households to purchase and finance homes on a forward basis.”

Many of these “constrained” borrowers have turned to Federal Housing Administration loans. FHA lending has been running at two to three times its pre-crisis level of 5 percent of loan volume. The data reveal that some of these borrowers have already begun to default. As of October, more than 4 percent of the $1 trillion in FHA loans were 90 days or more in arrears.

Distress is markedly higher among FHA loans for obvious reasons. The government-backed debt is the only source of mortgage availability for low-down-payment, subprime borrowers at a time when prices are rising relentlessly. A recent report from Black Knight Financial Services finds that a median-priced home now requires 22.2 percent of median income to make the necessary monthly principal and interest payments. Housing is about the least affordable it has been since 2010.

Subprime auto lending is a booming business. Of the $1 trillion in all such loans outstanding, some $300 billion are considered non-prime. According to S&P Global Ratings, subprime auto loans that are 60 days or more delinquent rose to 4.76 percent in November, almost double 2011’s rate. Net losses of 8.48 percent are also almost double that of five years ago.

While alarming, the stress isn’t what it was at its worst in the dark days of 2009. It’s critical to bear in mind that the subprime auto market hinges on used car lending. It’s telling that recovery rates are nosediving, with subprime loan balances recovering just 33.85 percent in November after factoring in payments received and what a car gets at auction. Almost 4 million cars are coming off leases in 2017, about 1 million more than in 2015.

Reports are emerging that subprime originations have begun to fall, leaving many of the smaller players chasing after the same borrowers who haven’t been approved by major lenders. In essence, they are essentially fighting over scraps, according to one industry expert.

All of this lending wouldn’t be possible if not for a mushrooming market for bonds backed by consumer loans, providing the financing that income gains failed to cover.

Then there’s credit card debt, which has been growing at an average of $5 billion a month since November 2015. Simple math dictates that outstanding balances will surpass the $1 trillion mark this month. While many applaud households’ increased usage of their credit cards as validation of their expected income gains, the five-month low in the saving rate suggests otherwise. In fact, inflation-adjusted credit card borrowing has outpaced that of real income growth since November 2015.

Add it up and consumer credit excluding mortgage debt is fast approaching 20 percent of gross domestic product, a record high and a full two percentage points above where it peaked prior to the onset of the last recession.

Lenders are getting nervous. According to the Fed’s latest senior loan officer survey, banks tightened lending standards for credit cards for the first time since 2010. Tighter standards were also reported for auto loans as lenders look to trim maturities, demand higher down payments and raise the floor on credit scores.

About 6.5 million homes have been lost to foreclosure since the economy went into its last recession, in 2008. Many economists dismiss the gravity of the 6 million auto borrowers who are at least 90 days late on their payments. Consider the other types of debt that have been tapped to make ends meet, and at some point, the trillions of dollars of at-risk household debt starts to add up. Is the happiness bubble also about to burst?

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Danielle DiMartino Booth, a former adviser to the president of the Dallas Fed, is the author of "Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America" (Portfolio: February 2017). She founded Money Strong LLC, a consulting firm.

To contact the author of this story: Danielle DiMartino Booth at Danielle@dimartinobooth.com.

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net.

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