U.S. consumers cut $1 trillion in debt; recovery still ‘painful’

The good news is that American consumers have paid off almost $1 trillion in debt since the third quarter of 2008. The bad news is that such payoffs have reduced consumer cash flow — ability to spend — by about $150 billion.

What’s more, economist Jeff Collins and others say responses by American consumers to the recession — which technically ended in June 2009 — and continuing unemployment trends indicate a slow and unsteady economic recovery for many months to come.

The Federal Reserve Bank of New York recently reported that household delinquencies were down 8.2% in the third quarter compared to the 2009 period. The $1 trillion in debt paid off since late 2008 did pull about $150 billion from the consumer’s ability to spend. However, the Fed report says the debt reduction comes from traditional debt reduction rather than consumer defaults on mortgages and other forms of borrowing.

“Consumer debt is declining but only part of the reduction is attributable to defaults and charge-offs,” Donghoon Lee, senior economist in the Research and Statistics Group at the New York Fed, said in the Fed report. “Americans are borrowing less and paying off more debt than in the recent past. This change, which we continue to study carefully, can be a result of both tightening credit standards and voluntary changes in saving behavior.”

Other key findings from the Fed report include:
• Household delinquent debt continues to decline and currently account for about $1.3 trillion or 11% of consumer debt, representing an 8.2% decline from a year earlier;
• The proportion of current mortgage balances that transitioned into delinquency rose slightly from 2.6% to 2.7%, after about a year of decline;
• About 457,000 individuals received home foreclosure notices on their credit reports between July 1 and Sept. 30, 2010, a 5.5% decrease from the second quarter and a 6.4% drop from a year earlier; and,
• The number of new bankruptcies noted on credit reports fell 16% from the previous quarter (from 621,000 to 522,000), but is 1% higher from a year earlier.

Collins, an economist based in Northwest Arkansas and the economist for The Compass Report, said consumer behavior noted in the Fed report is “predictable” and the behavior is likely to continue.

“Despite the highly favorable interest rate environment, changes in consumer behavior coupled with tightened lending standards likely imply continued thrift by U.S. households,” Collins explained. “The implications for the economy in the short-run from household debt reduction and reduced consumption are to weaken labor markets, particularly in sectors highly correlated to consumer activity.”

Indeed, labor markets continue to be weak.

Arkansas’ September unemployment rate was 7.7%, up from 7.5% in August and up from 7.5% in September 2009. September marked the 18th consecutive month that Arkansas’ jobless rate has been at or above 7%. The Oklahoma rate during September was 6.9%, down from 7% in August and unchanged from September 2009. The U.S. unemployment rate in September was 9.6%, unchanged from August and down from the 9.8% in September 2009.

The Fort Smith metro jobless rate was 7.7% in September, down from 7.9% in August and up from 7.5% in September 2009. The biggest unemployment decline was in the Texarkana area, with the rate moving from 7.8% in August to 7.1% in September. September marked the 21st consecutive month the metro jobless rate has been above 7%.

The Conference Board Employment Trends Index recently revised the index to 98.1, up from September’s revised figure of 97.3. The index is up more than 10% from a year ago.

“The improvement in the ETI in October suggests that negative job growth in the next quarter or two is very unlikely. However, we forecast sluggish economic activity until mid 2011, at the earliest. Employment growth will likely remain weak in 2011,” Gad Levanon, associate director, Macroeconomic Research at The Conference Board, said in the report.

Collins said economic stabilization is beginning to show up in labor markets, but American’s should expect a quick return to jobless rates prior to the recession.

“The key message is that the rate of growth is unlikely to accelerate to trend in the near-term. This means key statistics, such as the unemployment rate, are unlikely to improve to acceptable levels and the recovery will be slow and painful for many Americans,” Collins advised.

Barring another economic meltdown, Collins does see consumer benefits from the debt reduction and improving economic conditions.

“In the long-run, should the economy rebound consumers will have ample room to take on debt, assuming someone is willing to lend and interest rates haven’t been affected inordinately by imbalances caused by the growing federal debt,” he said.