Consumer Debt Drops For First Time Since 1945

The recession has had unanticipated consequences and not all bad in the eyes of some. U.S. consumer debt levels have dropped for the first time since 1945 and some see that as a positive sign for long term economic recovery.

Because of unemployment and falling house prices, many consumers have been forced to default on their mortgages or have simply walked away from their homes after turning the house over to the mortgage company. This has led to a decline in the amount of outstanding mortgage debt.

In addition, a general tightening of credit has led to falling credit card balances.

In 2009, the first drop in annual consumer debt since records were first kept in 1945 was recorded. The decline amounted to 1.7 percent compared to the prior year. The total outstanding consumer debt fell to $13.5 trillion.

In an ironic twist, the fact that consumers are finding themselves with a smaller debt burden means they have more free cash. More available cash means more spending and that is how the economy is expected to benefit.  Economists believe that the fact consumers have more cash to spend bodes well for a strong sustainable recovery.

Economists have understood for a long time that tight credit and new government regulation would lead to falling consumer debt, and a result, rising net worth. Debt as percentage of disposable income is falling putting many consumers on solid financial ground for the first time in many years. Shedding debt has brought relief to many households and they are finding that life is much more pleasant as a result.

Savings rates have been rising as the debt load has fallen. Yet total consumer debt remains at 122.5 percent of disposal income. In the fourth quarter of 2009, consumers saved at a 4.1 percent rate. The average consumer net worth as of the end of 2009 was at $175,600.

There are two facts to realize about the current situation. First is the fact that much of the debt reduction is the result of loan defaults. Second is the fact that defaults have impacted the ability of consumers to obtain credit. Even as their debt load falls, many of these same consumers will be unable to buy another house or get a credit card for a long while even if they wanted to.

The complexity of and interrelatedness of the factors impacting the economy are difficult to understand. Though economists have known that U.S. consumer debt would fall, they still do not know the shape of the emerging recovering economy. So much depends on how consumers decide to handle their money. Will they continue to save at a higher rate or revert back to old habits? Will a loosening of credit help offset consumers in default who now have difficulty taking out loans? Will consumers spend money at a rate that sustains economic growth?

U.S. consumers have enormous influence on both the U.S. and global economy. U.S. consumers account for up to one-fifth of global activity. It’s no wonder that economists are wondering what their plans are for financial management.