Drop in debt may hamper recovery

The amount Americans owe on credit cards and other consumer loans plunged a record $21.6 billion in July, clouding prospects that the budding economic recovery would soon extend to Main Street.

The drop in consumer debt for the month was the largest since the Federal Reserve began tracking the data in 1943 and the sixth straight monthly decline in outstanding consumer debt, the longest streak since 1991.

The amount of the decrease -- five times what analysts had predicted -- along with continued job losses and an uncertain housing market show that consumers are still skittish about borrowing money for big-ticket purchases, even though economic data show that the deep recession may have technically ended.

Consumer spending accounts for roughly 70% of the nation’s economic activity.


“People want to see where the economy is going before they commit to more debt. I wouldn’t make a major purchase right now,” said Norman Moore, a semi-retired computer consultant from North Hollywood, who has trimmed his debt and cut back spending.

Although paying down debt and getting finances in order is a good strategy for individual households, it doesn’t bode well for a nascent recovery in a nation deeply dependent on consumer spending.

“The consumer credit data highlights one of the key reasons why the economic recovery will be a bit of a slog, at least through this time next year,” said Mark Zandi, chief economist at Moody’s

“The credit crunch has abated since the financial panic was at its worst earlier in the year, but credit is not flowing normally,” he said. “Credit is the mother’s milk of economic activity, and until it flows more freely, the economy will struggle.”


Some economists cautioned observers not to read too much into July’s steep decline in consumer debt, which doesn’t include such long-term debt as mortgages.

Although the continued downward trend is a cause for concern, the economists said the big drop was affected partly by the government’s “cash for clunkers” program, which led consumers to put off borrowing money to buy cars until late in the month, when the initiative kicked in.

The deepest decline in July’s numbers was in the category dominated by auto loans, which fell by $15.4 billion. Nigel Gault, chief U.S. economist for IHS Global Insight, expects those nonrevolving loans to increase in August, when most of the $3 billion in clunkers deals were made, somewhat offsetting July’s record drop.

In the revolving debt category dominated by credit cards, consumers reduced their balances by $6.1 billion in July. That’s a decline at an annual pace of 8%, compared with June’s annual pace of 6.4%.


Analysts had estimated that the total consumer debt would fall by only $4 billion in July.

The continued decrease in the amount of debt held by consumers -- consistent with recent anemic consumer spending data -- shows that the economy is still weak.

“What we’re seeing is part of the adjustment . . . from an economy that was really driven by consumer spending and households building up more debt to one where consumer spending is going to be much more driven by income growth than it was in the past,” Gault said.

That’s the case for Paul Van Lierop, a Seattle area network engineer who has slashed his spending to pay off debt.


“I have always made good money, but I like the toys and am a spender by nature,” said Van Lierop, 37, who is married with two young sons. “After Christmas we came to the conclusion that we made too much money to feel broke all the time.”

The Van Lierops attended a personal finance class at their church and vowed to change their spending habits. The couple cut up their credit cards, devised a family budget and put some cash in a savings account for emergencies. They also started to use “every spare dollar to pay off debt,” he said.

Their debt included $62,000 in auto and credit card loans with interest rates as high as 24.9%. As of last week, the family had paid off $32,000, including all of the credit card debt.

Alan Levenson, chief economist at T. Rowe Price Associates, said consumers such as the Van Lierops were engaged in an unprecedented payoff of their debts. July’s steep drop surprised him, as it did many analysts, but he said that could partly reflect banks writing off more of their bad consumer loans.


“Even as the economy moves toward recovery, we’re going to see the saving rate rising,” Levenson said. “That’s going to limit spending.”

Consumer spending has been sluggish recently, rising 0.2% in July and 0.6% in June, the Commerce Department reported last month.

Meanwhile, consumer debt declined at an annual rate of 10.4% in July, according to the Federal Reserve data. Overall, outstanding debt fell from $2.494 trillion to $2.472 trillion.

But because of high unemployment, consumers still don’t feel confident; the August jobless rate jumped to 9.7%.


The Consumer Reports sentiment index this month fell to its lowest level since the height of the financial crisis last October, Consumer Reports magazine said Tuesday. Almost 38% of Americans had at least one major negative personal finance event in the last 30 days, the magazine reported.

Even those who borrow for big purchases are working to erase the debt as quickly as possible.

Paul Thomas, 56, spent $6,000 in July to purchase new kitchen appliances for his Long Beach condominium. He now owes less than $4,000 after making payments of more than $1,000 each in the last two months.

“I don’t have any car debt and I . . . only have a credit card balance for a big purchase like the appliances, but I will get rid of it quickly,” Thomas said.





Times staff writer Don Lee contributed to this report.