Navtej Kohli Business Blog

The way Americans go bust has changed fundamentally, and the implications for financial markets are both important and negative.

In the more innocent days before the debt bubble popped, vulnerable borrowers tended to do everything they could to hang on to their houses. The result was that they’d stop paying off their credit cards first, the car loan second and only last would they default on their mortgage.

But for many Americans in the credit bust, especially an overburdened minority, that set of priorities has been turned upside down.

“It’s the American way of deleveraging,” said Jochen Felsenheimer, credit strategist at Unicredit in Munich.

“First you sell your house, second you sell your car and in the end you also sell your TV set.”

The numbers bear him out. Subprime house loans started to go bad first, followed with a lag by subprime auto loans and now credit cards. Federal Reserve data show credit card debt more than 30 days delinquent increased sharply in the second half of 2007, by about 14 percent to 4.55 percent, the most since 2003.

In contrast, in the mid 1990s and during the slowdown in the early part of this decade credit card delinquencies rose before mortgage arrears, according to Federal Reserve data.

There are, of course, some crucial differences between then and now. Deteriorating lending standards allowed a group of less creditworthy borrowers to buy houses, and the amount people were obliged to make as a down payment fell. That meant that borrowers had less incentive to stick with their loans, as house prices went south and they found themselves owing more than the place was worth.

But the preference for car and TV set — or as it may be for car and groceries — over bricks and mortar suggests another disturbing possibility. A lot of people were living above their means and financing the shortfall through debt extracted from housing, credit card and auto lenders. While they had jobs, the jobs didn’t pay enough to actually retire the debt, just to keep current with the interest.

When housing started to fall, the natural thing to do was to preserve the car, which allows you to get to work, and especially the credit card, without which modern life is very difficult.

The implication is clear: credit card debt should continue to deteriorate as we’ve see mortgage debt do. This is bad for the people who make credit card loans, the already creaky and heavily hit financial sector.

Source: reuters.com

This entry was posted on Monday, March 10th, 2008 at 5:00 am and is filed under Business News, Business Trends. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.