We’ve seen the repercussions of the Great Recession on the financial services industry, not to mention the countless other aspects of our lives. Following the crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed into law in 2010, drastically altering how American consumers and businesses interact every day. Out of Dodd-Frank, the Consumer Financial Protection Bureau was created in 2011 to protect consumers’ interests from much of the predatory and deceptive practices that drove the Great Recession over the prior decade. Following the crisis and the ensuing new pieces of legislation, financial institutions began operating more conservatively: initially closing millions of, presumably, risky credit card accounts, introducing a stricter due diligence process when opening new accounts, and drastically shrinking their subprime originations – particularly subprime mortgages – portfolios. However, our perception of the “irresponsible credit card spending” preceding the crisis appears to not be as prevalent as we thought. In fact, credit card spending has been relatively stagnant despite massive credit card limit fluctuations over the past 14 years, according to data from the Federal Reserve Bank of New York.
The Credit Card Balance vs. Credit Card Credit Limit graph below illustrates the growth of credit card limits throughout the 2000s and into the Great Recession, followed by a sharp decline driven by the financial crisis’ fallout. Most importantly, we can see the massive disparity between the total credit card balances and credit card limits throughout this time period. Credit card balances ranged between $659 billion – Q1 2014 – and $866 billion – Q4 2008 – representing a 31.4 percent variance. This range is much smaller than credit card limits, which ranged from $2.55 trillion – Q1 2003 – and $3.7 trillion – Q3 2008 – a 45.1 percent variance. This suggests that consumers spend more conservatively than creditors lend since credit card spending is significantly less volatile than credit card limits.
The HELOC Balance vs. HELOC Limit graph below provides a visually easy and conceptually sensible contrast to the Credit Card Balance vs. Credit Card Limit one above. Home equity lines of credit (HELOCs) are another form of revolving credit – similar to credit cards – in which borrowers would have a certain credit limit and can draw as much money up to that limit until the ending period of the “loan”. In this sense, HELOCs are very similar to credit cards, albeit in a much more defined and less commonly used financial role – funding mortgage or housing payments – which may be why it follows a sensible trajectory. There’s no reason for HELOC borrowers to draw more funds and extend their credit limits if they don’t legitimately need additional funds. This habit and reasoning contrasts credit card users who may wish to increase their credit limits for numerous reasons, such as to increase their credit score or simply hedge against an unseen future credit need. Consumers are able to, more or less, continually raise and replenish their credit card limits, possibly explaining the difference in trajectories and trends among the two types of revolving credit.
When combining the credit card and HELOC balance margins – ratio of balances to limits – as we did in the following graph, we can see a difference between credit card and HELOC data. Not only do HELOC borrowers use a higher percentage of their spending limit than credit card users – as we alluded to previously – but it followed a much more standard path, hovering around 50 percent over the 14-year period. HELOC’s balance margin was actually at about the same rate in Q3 2016 as in Q1 2003, which strictly contrasts credit card balance margin’s trajectory. Credit card’s balance margin has fallen over time – most notably following the Great Recession – as consumer spending has grown more slowly than credit card limits.
The final, and most telling, observation substantiates this revelation, as shown by the Credit Card Balance Margin vs. Credit Card Limit graph below, which provides a closer look into the credit card balance margin above. The higher balance margin ratio in the early 2000s and during the Great Recession’s fallout may signal that credit card spending fluctuates quite wildly but this is actually wrong. The ratio fluctuates not because spending increased, but rather due to credit limits dropping considerably from $3.7 trillion in Q3 2008 all the way down to $2.87 trillion in Q4 2009, which happens to be the peak of the balance margin metric. The two metrics almost align perfectly, as the graph below shows, suggesting that the credit card limit changes has a strong, inverse effect on the credit card balance margin – when the limit increases, the balance margin almost perfectly reflects a mirrored decrease.
The data revealed in the previous graphs suggests that overall credit card spending trends independently of credit card limits. Even if a creditor increases a borrower’s credit limit, the borrower’s spending habits, on average, remain the same. As such, there may be better economic determinants to project credit card spending habits, such as the number of active credit card accounts or increases in real disposable income. ARM industry-participants operating in the financial services market should monitor how regulations change in the near future, specifically related to access to new lines of credit – not necessarily the actual average credit limits per account. Specifically, if President-elect Trump goes through with his plans to deregulate the financial services industry – and economy as a whole – then, based on our analysis, the ARM industry-participants mentioned previously should not assume an increase in credit card spending habits.
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