Consumer credit falls again!

Yesterday I discussed how the failure of mortgage-backed securities (MBS) has compounded the foreclosure rate, see here.  Today, however, I wanted to comment on the Federal Reserves' (the Fed) report regarding consumer credit, see here.

The report basically notes that consumer credit has shrunk over the past year, which shouldn't come as a surprise.  The extreme use of MBS and CDS by banks and other entities--such as hedge funds, money market funds, and other investment vehicles--really pushed the our economy to the edge of a cliff.  While the economy may have taken a step back from the edge, there are two points to keep in mind.  First, no one knows the depth of the ravine, at least not with any certainty.  We still don't how interconnected the players in our global economy are to each other.  Second, there is still a great deal of risk left in the economy.  While many talking heads are claiming the worst is behind us, I'm not convinced and you shouldn't be either.

So what does this have to do with consumer credit?  First, banks are not out of the clearing.  They are still suffering from losses and in all likelihood more are coming.  This means they need to retain more capital reserves (i.e. money in the bank).  That means less money for lending and, consequently, stricter standards that prohibit some people from getting credit (and probably rightly so).  Second, the Great Recession has left some people unemployed, others scared, and others with little or no reason to save.  Those unfortunate people who have lost their jobs have probably already maxed out any credit lines--so no growth here.  Those who are still scared are likely to focus on paying down debt or, at least, limiting their exposure to credit.  Finally, the Feds' federal funds target rate is still set between zero and one percent.  This means banks can borrow cheaply.  It also means saving rates are worthless.  Most people would prefer to pay down debt that is costing them 5 percent or more a year than stash money that earns almost no interest.

As result, consumer credit is still shrinking and this raises another concern: what area of the economy will any recovery stand on?  Real estate is falling, consumer spending is falling, unemployment is high, and the government is running out of stimulus money.  Basically, that leaves traditional engines of growth such as manufacturing.  Its time for some good ol' American ingenuity to kick in.