Dwindling savings and rising debt leave consumers in dire financial straits

WASHINGTON — U.S. households have reduced their savings and taken on mounting debt, putting many in a weaker position to weather an economic downturn made all the more likely in the wake of recent turmoil in the banking sector.

Fears of a slowing economy were renewed this week as U.S. regulators took over Silicon Valley Bank, Swiss officials stepped in to shore up Credit Suisse’s finances and a group of Wall Street firms threw a lifeline at the First Republic Bank.

The events have drawn parallels with the 2008 financial crisis and are likely to cause banks to tighten lending, putting further pressure on already strained consumers, which in turn could cause them to cut back on spending. and trigger layoffs at companies facing declining sales.

“What we’re seeing right now, in terms of banking sector stress, is likely to have amplifying effects on deteriorating household finances,” said Gregory Daco, chief economist at EY-Parthenon. “We are likely to see an environment where banks are more cautious with their lending, especially smaller regional banks, and that will further compound the easing that we were already seeing.”

Goldman Sachs on Thursday raised its chances of a recession by 10 percentage points, to 35%. Other economists are even less optimistic about the ability of the United States to avoid an economic slowdown, with those polled by Bloomberg putting the odds of a recession at 60%.

For most of the past year, as inflation hit its highest level in decades, consumers have largely been able to continue to increase spending. While retail sales fell slightly in February from January, they still rose 5.4% from a year earlier, the Commerce Department reported this week.

Credit and debit card data from Bank of America for February showed spending per household rose 2.7% year over year, which “suggests to us that consumer spending remain resilient even as the rate of spending growth moderates,” according to a report last week from the Bank of America Institute.

But the data indicates that wages have not kept up with inflation during this period. As a result, Americans have increasingly turned to credit cards and savings accounts to maintain their spending habits.

“The average person’s finances were probably better a year or two ago than they are now simply because they had more cash and had less debt,” said Ted Rossman, senior industry analyst at Bankrate.com. “There was a time in early 2021 when credit card balances were 17% lower than they were before the pandemic. And now they are up 28% from that low point. »

According to a report by JP Morgan.

At the same time, the percentage of people’s wages spent on savings has fallen to about half of what it was before the pandemic, according to data from the Federal Reserve Bank of St. Louis.

Meanwhile, the amount of debt Americans have skyrocketed. Credit card balances rose $61 billion to a record high of $986 billion in the last quarter of 2022 — a rapid reversal from two years ago, when Americans paid off their debt with checks stimulus, according to data from the New York Federal Reserve. Auto loan balances increased by $94 billion.

There are signs that a growing number of consumers are having difficulty repaying this debt.

The percentage of credit card holders with month-to-month debt rose to 46% from 39% a year ago, according to Bankrate. Auto loan delinquencies have steadily risen from their pandemic lows, with the share of auto loans at least 60 days past due at its highest level since 2006, according to a report last month from Cox Automotive. .

All of these factors have investors, economists and business executives keeping a close eye on the changes the Federal Reserve will make to interest rates next week. Another round of rate hikes would make it more expensive for consumers to borrow money to finance a home or buy a car, or to carry over credit card balances. It will also put pressure on businesses looking to borrow money.

But with persistently high inflation — up 6% in February from a year earlier — some economists say the Federal Reserve has no choice but to keep raising rates to cut spending.

Another key factor economists say they are watching is the labor market, which has remained strong in part because consumers have held on to spending.

Job creation slowed in February but remains stronger than expected, with the economy adding 311,000 jobs, the Labor Department reported last week. The unemployment rate rose to 3.6%, which is relatively in line with its level of last year. But even a slight rise in unemployment could cause millions of Americans to cut spending.

“The backbone of consumer spending activity is the labor market,” said Daco, the economist. “If the labor market begins to show more significant signs of cooling, moderating, weakening, this will have a direct effect on household incomes, and therefore on their ability and desire to spend.”