What’s Worse: Stingy Banks or Thrifty Consumers?

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There have been a lot of people blabbing on for the past few months about the new found thriftiness of the American consumer. The savings rate is up, and credit card balances are down. Well it appears, that that later piece of news does not fit as neatly into the thriftier American thesis as it appears. A new study by CardHub found that while credit card debt did fall $93 billion in 2009, a cool $83 billion of that drop, or 89%, came from banks charging off loans, not, as people thought, from customers paying down balances. In fact, when you adjust for the charge offs, consumers actually loaded up their credit cards with an additional $21 billion in debt in the last three months of 2009 alone.

Felix Salmon over at Reuters sees some pretty discouraging stuff here and does a good job of explaining why credit card debt has been and probably will remain so sticky.

But we’re also going to need a change in the national mood, and a rediscovery of the virtues of thrift which seemed resurgent for such a short time. Frankly, that’s not going to happen. And the new credit card rules won’t help: by making it cheaper to have and service credit card debt, they also make it more attractive to do that.

But, at least in the short term, I’m not as convinced this is all bad news. Here’s why:

First of all, to the individual consumer, whether they pay down their debt or whether it is charged-off by the bank really doesn’t matter that much. It hurts their credit, but the net affect on their individual balance sheet is the same thing: They owe less money. That’s good. In the same way that consumers walking away from their heavily indebted homes can lead to economic recovery, banks charging off debt can do the same thing by improving an individual’s finances.

Second, one of the biggest concerns about the recovery is the fact that despite the economy seeming to be turning up, credit in the US continues to contract. Why? One side, mostly the banks, say it is because consumers and businesses don’t want to borrow. That means it is a demand side problem. The other side, which is pretty much everyone else, says credit is contracting because banks don’t want to lend. In that case, it is more a problem of the supply of credit.

The original story line that credit card debt was shrinking because people where paying off their cards seemed to back up the argument that the lack of lending was a demand problem. That’s a big problem. Consumers make up 70% of the US economy. So without them there probably wasn’t going to be any sustained recovery. Why we spend has a lot to do with confidence and our outlook for the future. That is very hard to change.

The CardHub report suggests that the demand argument is wrong. Credit card lending is falling because banks are cutting consumers off. And so this is much more of a supply side problem. When it comes to credit, neither demand nor supply problems are easy to fix fast. But my guess is that the supply side problem is the easier one to tackle. Banks generally want to lend. They are incentivized to do so. That’s how they make money.

What’s more, the Fed has ways to get banks to lend. The government can pump more money into banks. The Fed can even start to essentially lend money itself, by buying up bonds. Yes, it has done a lot of this stuff already and lending has dropped, but not nearly as much you would have expected. And as the economy improves I would suspect that banks will become willing very quickly to lend again. If existing banks are too battered, persistent low interest rates should cause new banks to pop up to fill the void.

Conversely, it seems to me it would be much harder to get reluctant consumers to spend. Unlike the banks, increased borrowing is actually bad for consumers. The one tool the government has to boost spending is tax cuts. But tax cuts are very expensive, and generally an inefficient way to stimulate the economy.

Now it is true that for the long term health of the US economy we all need to save more and borrow less. But in the next year or so, if we are to have a sustained recovery, I think we would be much better off with stingy banks, than with thrifty consumers.