Plastic’s Problem: Falling Credit Card Debt

by Alyssa Oursler | September 21, 2012 6:45 am

Investors all around have been pretty bullish on credit-card companies as of late. There’s plenty of reasons behind their success, but one of the biggest drivers is one of the simplest: More and more people are paying using plastic.

Banking and payment services outfit Discover Financial (NYSE:DFS[1]) has been the poster child for this trend[2] in 2012, with eye-popping 64% gains so far. And the big processing names — Visa (NYSE:V[3]) and MasterCard (NYSE:MA[4]) — have been steadily climbing as well, with shares respectively 33% and 22% in the black.

But one thing seems to have been lost in the rampant euphoria.

It’s not that people are saying they’ll switch to other forms of payment now that credit card surcharges are now allowed, Talk is cheap, and I don’t buy that for a second[5].

No, there’s a much more real and immediate issue with credit card companies, and it’s pretty simple: People might be using credit cards more, but they’re piling up less debt with them. And lower credit card debt (and logically, less use) means less interest, processing fees and debt services for those companies.

Consumer credit card debt fell for the past two months, including an unexpected $3.28 billion drop in July[6] that actually caused consumer borrowing overall to decline for the first time in almost a year.

Part of the problem, of course, is that consumer spending all around has been weak in the wake of the crisis. But such spending, according to some reports, actually is set to explode[7], so problem solved … right?


Just look at this fact: In July — when, again, consumer credit fell — spending actually increased by its greatest rate in five months[8]. So the predicament is clear: Even though people are slowly starting to spend again, they aren’t piling up large amounts of credit card debt in the process.

So what gives? Well, consumer debt fell significantly in the beginning of the Great Recession. That decline, though, wasn’t because people were paying off their debt; instead, it was mostly the result of foreclosures. In fact, about two-thirds of debt reduction in the U.S.[9] came from folks defaulting on loans.

Those foreclosures came as the housing bubble popped, of course, and values — which consumers had, to a large extent, counted on to qualify for and repay debt — plummeted.

So off the bat, the backstop was pulled out for many Americans, and they lacked the wealth to handle their loans. But it doesn’t end there.

Now, lenders are being more cautious after getting burned during the downturn. And many people can’t qualify for as much credit as it is, considering they lost hundreds of thousands of dollars in home equity over the past few years.

Even consumers who can still qualify for debt are being more cautious as well.

It’s almost no wonder that 85% of middle-class Americans[10] say it is harder to maintain their standard of living now than it was a decade ago. Sure, there’s that whole issue of low-income jobs being added in the recovery and unemployment and falling wages. But there’s also the fact that people are actually living within their means — not based on the expected appreciation of their home, or thanks to the debt they pile up thanks to the credit for which they qualify.

And the cycle just keeps on going.

See, for past generations, banking on rising home values made sense because it seemed like they couldn’t stop rising. But once prices not only stopped climbing, but dropped significantly, members of Generation Y undoubtedly took note.

As we’re learning from the Great Recession, yesterday’s restraints are becoming today’s austerity habits. Thus, the idea of piling up debt to pay back with appreciating home equity not only is foreign to many of the up-and-coming generation but — considering home equity got crushed by more than 60% during the crisis[11] — the notion probably seems downright crazy.

Millennials already are saddled with record-amounts of student debt, oftentimes alongside low-paying jobs[12]. They’re showing a preference for renting rather than owning[13], too. So digging an even deeper hole through credit-card debt probably is the last thing on young adults’ minds after graduation.

That’s not to say that there aren’t plenty of reasons to be bullish on credit card companies, or that their success will suddenly come to a screeching halt. There are, and it shouldn’t.

Nor is that to say that the economy itself won’t get back on track, and bring an appetite for credit with it.

But aversion to debt is something that simply can’t be ignored anymore when evaluating companies in the credit-card business — especially in the wake of years of outsized gains.

As of this writing, Alyssa Oursler did not own a position in any of the aforementioned securities.

  1. DFS:
  2. poster child for this trend:
  3. V:
  4. MA:
  5. I don’t buy that for a second:
  6. unexpected $3.28 billion drop in July:
  7. actually is set to explode:
  8. its greatest rate in five months:
  9. two-thirds of debt reduction in the U.S.:
  10. 85% of middle-class Americans:
  11. more than 60% during the crisis:
  12. alongside low-paying jobs:
  13. preference for renting rather than owning:

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