Consumers continued their pandemic-era rebalancing of household finances in the first quarter, shedding credit card debt and home equity lines of credit. These adjustments to household balance sheets appear consistent with increases in government transfers and changes in buying habits during the pandemic.
Government efforts to maintain income streams and spending during the pandemic have been successful.
The improvement in household finances underscores the powerful release of pent-up demand that will be the foundation of this year’s economic boom and provide the overarching narrative for the first phase of the recovery and expansion.
Government efforts to maintain income streams and spending during the pandemic have been successful, as evidenced by the recoveries in retail sales and in personal consumption expenditures since the depths of the pandemic.
In one sense, those government transfers to households have in a modest way created the conditions for the rehabilitation of millions of Americans’ balance sheets in a manner that is not too dissimilar from what was done over a decade ago, when the government sponsored a de facto bailout of large and systemically important banks.
But not all of those fiscal transfers have gone into spending. Instead, a significant portion is being retained by households as precautionary savings, either outright or through the paying down of debt. At this point, our estimation is that households will largely save 30% of those government transfers, use 30% to pare down debt and spend 40% of them over this year and next.
We categorize paying down debt as a form of precautionary savings, in which households give themselves more room to maneuver if expenses once more overwhelm available income during the inevitable economic shakeout of the post-pandemic recovery.
This should also reinforce the improvements in household balance sheets and the overall economy as Americans gain confidence in their own financial conditions.
Credit card debt was reduced by $157 billion in the five quarters of the pandemic (from the end of 2019 through the first quarter of 2021), including a $49 billion drop during in the latest quarter. Credit card debt was growing at a five-year average rate of 5.4% per year before the pandemic, but grew by only 2.6% on a year-over-year basis in the first quarter of 2021.
Home equity lines of credit were reduced by $55 billion during the five quarters of the pandemic, including a drop of $14 billion in the first quarter of 2021. Home equity financing has been in general decline since the early 2000s, with negative growth since 2012.
According to an analysis by the Federal Reserve Bank of New York, in total, “non-housing balances declined by $18 billion, with increases in auto and student loans offset by the declining credit card balance.”
First quarter consumer credit in five charts
Total consumer credit grew by 0.6% in the first quarter compared to end-of-year 2020. On an annualized basis, that would be a growth rate of 2.4% in 2021 were first-quarter growth to continue for the rest of the year. By comparison, total consumer credit had been growing at an average 3.5% yearly rate in the five years before the pandemic.
Mortgage debt grew by 1.2% in the first quarter compared to end-of-year 2020. On an annualized basis, that would be a growth rate of 4.7% in 2021, compared to its five-year pre-pandemic average 3.0% yearly rate.
At least some of those increases in mortgages outstanding can be attributed to shifts in housing preferences and the hot housing market during the pandemic.
Auto loans grew by 0.6% in the first quarter compared to end-of-year 2020. On an annualized basis, that would be a growth rate of 2.3% in 2021, compared to its pre-pandemic five-year average 7.4% yearly rate.
This runs counter to the narrative regarding the drop in inventory. But there are also consumer preferences that have shifted to less expensive used cars and to general cost-cutting by households that most likely account for the long-term declining trend in the growth of auto loans.
Credit card balances declined by 6.0% in the first quarter compared to end-of-year 2020. On an annualized basis, that would be a drop of nearly 22% in 2021, compared to its five-year pre-pandemic average 5.4% yearly growth rate.
This growing reluctance to accumulate debt among households, should it continue beyond the vaccination program, might not become a drag on the economy if households were to instead reduce their precautionary savings, if wage increases were to sustain their pandemic gains, and if infrastructure programs were to accomplish their goals.
Student loans outstanding grew by 1.9% in the first quarter compared to end-of-year 2020. On an annualized basis, that would be imply an increase of 7.7%% in 2021, compared to its pre-pandemic five-year average 5.8% yearly growth rate.
This should not be confused with the rising cost of higher education, which is dependent on household preferences and a self-imposed limit to the supply of choices. In the absence of options, however, a persistent increase in education costs is likely to have a sustained effect on household expenses and an impact on overall inflation.
Long-term trends in consumer debt
Mortgages hold the largest share (69%) of consumer debt and form the backbone of modern American life and wealth accumulation. Housing costs are followed by student loans, which now make up 11% of consumer credit, and auto loans at 9% and credit card debt, which holds a 5% share.
The largest increase in the composition of debt has been in student loans, which grew from 5% of total credit in 2008 to their 11% share in 2021. Home equity lines of credit — which were once so popular and in 2008 held a 6% share of total consumer credit — now hold a 2% share.
The shedding of debt during the pandemic – if it continues – would be part of a rebalancing trend after the postwar era of consumerism. The turning point appears could have resulted from lessons learned in the early-2000s housing bubble and the financial crisis.
But the restructuring of household finances is more likely to have resulted from decline of wage growth after the Great Recession, when the manufacturing sector was hollowed out, worker representation diminished, and wages and worker benefits barely kept up with normal levels of inflation.
The takeaway
We are in a cycle of an inordinate amount of savings pressuring the return on investment lower and the moderation of wages, inflation and economic growth. Whether this era of belt-tightening continues might depend on the ability of the government to invest in a reimagined economy and to foster a new avenue for prosperity to develop. Reimagining a 1950s economy is an insufficient answer to a long-term problem to today’s circumstances.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
