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Consumer installment credit, 1980-85.

Consumer Installment Credit, 1980-85

CONSUMER installment credit, which accounts for about 80 percent of total consumer credit, has expanded substantially over the first half of the 1980's. Such credit is extended to individuals through business channels --commercial banks, finance companies, retail establishments, and thrift institutions--to finance purchases of goods and services over a period of time. The Federal Reserve Board, which collects the data, distinguishes four categories: auto, mobile home, revolving (mostly credit cards), and "other' (mainly personal loans). The availability and terms of installment credit, as well as the extent to which consumers are already indebted, can affect the ability and willingness of consumers to purchase goods and services, and thus affect the course of the personal consumption expenditures component of gross national product.

Legislation passed in 1980 loosened some of the lending and deposit restrictions on financial institutions and thereby helped bring about significant changes in consumer credit markets. In addition, better informed borrowers, demographic shifts, and lengthening loan maturities have had an influence. This article, which can be viewed as updating "Consumer Credit, 1960-80,' an article in the February 1981 issue of the SURVEY OF CURRENT BUSINESS, will discuss patterns in consumer installment credit and related developments from 1980 through the first half of 1985.

Overview, 1980-84

Consumer installment credit outstanding reached $452 1/2 billion at the end of 1984, a nearly 50-percent increase since the end of 1979 (chart 1). Credit outstanding declined in 1980, increased moderately in 1981 and 1982, and increased sharply in 1983 and 1984.

Following large increases during the late 1970's, consumer installment credit outstanding at yearend 1980 was down 3 1/2 percent from a year earlier. Auto and "other' credit accounted for the decline, which was the result of several factors that affected borrowing as well as lending. Borrowing was discouraged by a sharp jump in finance rates; finance rates on most types of consumer loans jumped 2-3 percentage points during the first part of the year (chart 2). A recession during the first half of the year also discouraged consumers from taking on debt; uncertainty about employment and the economic situation in general increased consumer reluctance to purchase the large-ticket items--durable goods, in particular-- that are frequently financed with credit. Lending was curtailed by temporary credit restraints initiated in March by the Federal Reserve Board, as part of an overall anti-inflation program.

Installment credit outstanding increased 5 1/2 percent in 1981 and 5 percent in 1982. All categories of credit increased, but the increases in "other' credit were substantially smaller than in the remaining categories. A recession from mid-1981 until late 1982 and increases in finance rates to record highs--ranging from 17 to 19 percent--during the 1981-82 period affected the expansion of credit, as did emerging effects of several long-term developments, discussed in the next section.

Credit outstanding increased 14 1/2 percent in 1983 and 20 1/2 percent in 1984. All categories of credit registered large increases; as earlier in the 1980's, the largest was in revolving credit. The acceleration reflected the vigorous recovery in consumer demand and declines in most finance rates. Finance rates--except on credit cards--declined in 1983, increased slightly in mid-1984, and then turned down again. By the end of 1984, they were 3-4 percentage points below those registered 2 years earlier. The finance rate on credit card purchases remained at 18-19 percent throughout the period.

Cyclical comparisons show that the behavior of installment credit outstanding during the recession from mid-1981 until late 1982 and during the ensuing recovery and expansion has not been dramatically different from other post-World War II business cycles (chart 3). However, two differences can be noted. First, the flattening typically experienced during the later stages of a recession and immediately afterward did not occur; instead, the series continued to increase, albeit slowly. Second, increases since the first quarter of 1983 have been somewhat stronger than in corresponding timespans following most recessions. The strength during the most recent cycle was attributable to various factors, which affected both extensions and repayments of credit. Curtailed borrowing during late 1979 and 1980 resulted in lower loan repayments over the next 2-4 years; in turn, lower repayments--because lenders net repayments against extensions in deriving credit outstanding-- had the effect of raising the level of credit outstanding. At the same time, several of the long-term developments increased extensions of credit, especially in 1983 and 1984.

Long-term developments affecting consumer credit

Several long-term developments affected consumer installment credit in the 1980's. Two of these--consumers' increased awareness and understanding of credit instruments, and financial deregulation--interactively led to the expansion of credit and greater competition in consumer loan markets. Increased consumer understanding has been fostered by the Truth in Lending section of the Consumer Credit Protection Act of 1968. Surveys conducted by the Federal Reserve Board and the National Commission on Consumer Finance suggest that consumer awareness of annual percentage rates and of credit's cost in dollar terms has increased since the implementation of Truth in Lending. Moreover, the surge in interest rates in the late 1970's and the proliferation of credit instruments that followed led consumers to "shop' more carefully for credit than they had in the past.

The Depository Institutions Deregulation and Monetary Control Act of 1980 eliminated many of the traditional differences among financial institutions. The act called for the gradual elimination of ceilings on loan rates and the easing of restrictions-- based on an institution's assets or on georgraphical boundaries, for example --that had limited extensions of credit and competition for consumer loans. Deregulation also helped these institutions compete more directly for deposits--both with each other and with less-regulated investment and securities firms--by lifting ceilings on deposit interest rates (controlled by Regulation Q). More institutions were permitted to provide interest-bearing checking accounts, remote service facilities (such as teller machines in supermarkets), and higher yielding accounts, such as money market and negotiable order of withdrawal (NOW) accounts. The resulting inflow of new deposits at many institutions increased funds available for consumer loans.

Another development that has contributed to the expansion in installment credit outstanding in the 1980's is the increasing consumer use of credit bank cards such as VISA and MasterCard, as well as retailers' cards--as a convenient substitute for cash. In this case, the amount charged is paid in full by the first payment due date and no finance charge is incurred. Used as a cash substitute, credit is, strictly speaking, not installment borrowing; nevertheless, if payment has yet to be received, the balances are included in lenders' end-of-the-month reports of installment credit outstanding. The extent to which this "convenience' use--which, according to surveys by the Federal Reserve Board, may constitute as much as 50 percent of credit card purchases--affects the level of credit outstanding is difficult to measure.

A relatively small part of the increase in installment credit outstanding in the last several years may be attributed to an increase in the proportion of the population that is 25-44 years old. This age group has historically incurred higher levels of debt than any other, because of the large expenses associated with starting households and families--for example, buying furniture and household equipment. The effect of this demographic shift can be estimated by comparing the actual level of debt with what the level would have been if the shift had not occurred. Using this method, the Federal Reserve Board estimated that the shift raised the level of debt in 1983 by one-half percentage point.1

1. The average levels of debt for each age category in 1983 were weighted by the age distributions associated with these levels in 1977 and in 1983; the two weighted-average totals differed by one-half percentage point. See Charles A. Luckett and James D. August, "The Growth of Consumer Debt,' Federal Reserve Bulletin 71 (June 1985), p. 399, for a more detailed explanation of this calculation.

In addition, average maturities on many consumer loans have been increasing, most significantly since 1983. For instance, during 1984, the average maturity on new auto loans increased 4 months (to slightly over 50 months); in prior years, increases had been more gradual. Other things being equal, longer maturities--by stretching out repayments over a longer period of time--initially lower repayments, and thus raise the level of credit outstanding.

Distribution of installment credit outstanding

The top panel of table 1 shows the yearend distribution of installment credit outstanding, by type of lender, for 1980 through 1984. Some of the shifts in distribution that have occurred over this period reflect developments discussed in the previous section.

The share of commercial banks, which account for the largest percentage of installment credit outstanding, declined about 4 percentage points from 1980 to 1983, but a slight increase during 1984--attributable to a pickup in auto loans outstanding-- brought their share to 46 percent at yearend. By type of credit, auto loans accounted for 41 percent of commercial bank installment credit outstanding; revolving and "other,' 27 1/2 percent each; and mobile home, 4 1/2 percent. Revolving credit was the only share that increased over the period, reflecting the greater use of bank credit cards.

Finance companies held slightly more than 21 percent of installment credit outstanding in 1984, about the same as in 1980. Auto credit accounted for the largest share--57 percent; "other' and mobile home credit accounted for 33 1/2 percent and 9 1/2 percent, respectively, at the end of 1984. The large share of auto loans reflects the inclusion in this group of the financial subsidiaries of the three major U.S. automobile manufacturers. An increase of 2 1/2 percentage points in the finance companies' share during 1981-82 was primarily in auto loans, as the automakers' subsidiaries offered below-market finance rates to support new car purchases. The subsequent decline in finance companies' share during 1983-84 resumed a downward trend. The auto and mobile home shares increased over the 1980-84 period. "Other' credit decreased, as finance companies began to cut back on personal loans in favor of less risky commercial and secured loans. Increases in operating costs narrowed the earnings margin on consumer loans; some of the higher costs were associated with changes in bankruptcy laws that, combined with high finance rates, led to an increasing number of personal bankruptcies and uncollectible consumer loans.2

2. Personal bankruptcies increased during 1980-82, partly a result of the Bankruptcy Reform Act of 1978, which made it easier to declare bankruptcy. This increased the risk to lenders of making unsecured consumer loans.

Credit unions have maintained a steady share of 14-15 percent of installment credit outstanding. The distribution was virtually unchanged: "other,' 51 percent; auto, 48 percent; and mobile home, 1 1/2 percent. In the past, credit unions were only limited competitors of banks and thrift institutions for several reasons--their relatively small size, limited offerings of services, and the "common bond' requirement for membership. The effects of deregulation, along with a more relaxed interpretation of "common bond,' have helped credit unions compete with other financial institutions, despite some remaining size and membership limitations.

Saving and loan associations and mutual savings banks sharply expanded their share of installment credit over the last 4 years. The share of installment credit held by savings and loan associations doubled to 6 1/2 percent in 1984. For savings and loan associations, "other' credit accounted for a larger share, and mobile home, a smaller share, of their total than in 1980. Mutual savings banks accounted for 2 percent of credit (all in the "other' category) in 1984, up from 1 1/2 percent in 1980. In the new competitive environment, these thrift institutions have sought to increase their extensions of installment credit. The relatively higher rate of return on these loans has enabled them partly to offset low returns on long-term fixed-rate assets, such as mortgages, and the higher rates paid to depositors on the new types of accounts.

The share of retail establishments --retailers and gasoline companies --decreased from 10 1/2 percent in 1980 to 9 percent in 1984. For retailers, revolving credit increased, but "other' credit declined. The decline in the share of credit held by gasoline companies probably reflected the availability of discounts for cash purchases of gasoline.

The bottom panel of table 1 shows the distribution by type of installment credit for 1980 through 1984. The most significant change was the steady increase in the share accounted for by revolving credit--from 18 1/2 percent in 1980 to 21 percent in 1984. The increase reflected the spread of bank credit cards and a switch by many retailers to billing accounts on a revolving basis, as well as the increasing "convenience' use of credit cards as a cash substitute. Revolving credit has increasingly been used both for inexpensive items, which previously might have been paid for in cash, and for more expensive items, which previously might have been financed by a personal loan.

Measures of debt burden

Several measures of consumer debt burden that are useful in assessing the ability of consumers to meet their obligations or to incur additional debt are shown in chart 4. One of the most frequently cited is the ratio of consumer installment credit outstanding to disposable personal income. This ratio, after declining to a low of 14 1/2 percent in 1982, reached 17 percent in 1984--less than 1 percentage point below the previous peak in 1979. The steadily increasing debt-to-income ratio and its nearness to its previous peak might be viewed as indications that consumers are beginning to reach their borrowing capacity. However, due to the "convenience' use of credit cards, the increase in the debt-income ratio may be overstated as a measure of borrowing capacity. If revolving credit is excluded, the resulting ratio reached 13 1/2 percent in 1984--more than 1 percentage point below 1979.

Measures of consumer resources other than income can also be used to evaluate debt burden. Financial assets, such as savings and some money market accounts, can be easily liquidated, and thus are a resource that may be drawn upon to repay debt. Other assets on consumer balance sheets, while not as liquid, can be used as collateral for liabilities incurred. Ratios of debt-to-financial assets and debt-to-net worth, which take these other assets into account, show patterns similar to the burden measures based on income.

Although useful as general indicators of how consumers are managing their debt, measures of debt burden do not take into account the respective distributions of debt and income or net worth among consumers. Data on the proportion of households in debt and shares of total debt outstanding by income group, based on Federal Reserve Board surveys of consumer finances in 1977 and in 1983, shed light on some of these relationships, as well as on other characteristics underlying the debt ratios. The data showed that, as income increased, debt outstanding did not increase as much and the debt burden decreased. From 1977 to 1983, the proportion of households in debt increased for the five income groups: for the lowest income group, from 30 to 32 percent; and for the highest income group, from 57 1/2 percent to 72 percent. In 1983, the share of total debt accounted for by these groups was 5 percent and 45 1/2 percent, respectively. The large increase in debt outstanding over the period was mainly attributable to high-income families, who are generally better able to handle the burden.

Survey results also showed that there was not a strong relationship between mean total consumer debt outstanding (installment and noninstallment) and net worth. Unlike debt, net worth was very heavily concentrated in a small number of families in the upper income groups. In addition, about 20 percent of families in the survey had zero or negative net worth. These findings suggest caution in the use of the debt-to-net worth ratio as an indicator of the overall ability of consumers to handle debt.

The delinquency rate, which is the percentage of consumer installment loans held by commercial banks that have a payment past due for 30 days or more, is another indication of how well consumers are managing their debt. This rate fell during 1982 and 1983. The decline during 1982 was unusual; delinquency rates have typically risen during recessions. The rate increased slightly during 1984, to 2.1 percent by yearend.

Recent developments

By June 1985, consumer installment credit outstanding totaled $501 billion, a 22 1/2-percent increase (annual rate) from the level at year-end 1984. The continued large increases in 1985 were spurred, in part, by further declines in finance rates, to the lowest since 1980. Rates on most consumer loans were in the range of 13 to 16 percent by midyear, with the exception of those on credit card purchases, which remained at 18 1/2 19 percent. As in 1984, the largest increases in credit outstanding were in the auto and revolving categories and were sharper than earlier increases. These increases reflected, for auto credit, further increases in the average maturity on new auto installment loans to over 51 months, and, for revolving credit, the expanding use of credit cards. "Other' credit registered another strong increase, and mobile home credit increased moderately, roughly in line with the 2 preceding years. By type of lender, the growth in credit outstanding was strongest for commercial banks, mirroring the large increases in auto and revolving credit. In the continued competitive environment, savings and loan associations further expanded their share of the installment loan market, largely through increased holdings of "other' credit. The shares of other types of lenders were either about the same as or slightly smaller than in 1984.

The debt-to-income ratio reached 18 1/2 percent in June 1985, surpassing its previous high of 18 percent; the ratio excluding revolving credit reached its previous high of about 14 1/2 percent. These measures of burden indicate that credit outstanding is approaching a point where, historically, there was concern about borrowers overextending themselves and the rate of increase in credit began to taper off. However, several developments, as discussed earlier, have altered some of the historical relationships. The effects of the increasing "convenience' use of credit on the level outstanding are not easily sorted out, but have played a role in the increase in the debt-to-income ratio. Another factor, the longer average maturities on consumer loans, has also tended to raise credit outstanding in the short run. In addition to these changes, consumers' greater awareness and understanding of credit instruments may mean that increases in credit outstanding were based on better informed decisions.

Table: 1.--Consumer Installment Credit Outstanding by Type of Lender and by Type of Credit

Photo: CHART 1 Consumer Installment Credit Outstanding

Photo: CHART 2 Finance Rates on Conaumwe Loans

Photo: CHART 3 Consumer Installment Credit Outstanding: Cyclical Comparisons

Photo: CHART 4 Debt Burden Measures
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Author:Tapscott, Tracy R.
Publication:Survey of Current Business
Date:Aug 1, 1985
Previous Article:The business situation.
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