A recent study of the relationship of debt to liquid assets explains that consumers carry expensive credit card debt while they have resources because they seek to protect their liquid assets to pay monthly and necessary expenses.
Credit card debt has been examined for decades, according to an August 2022 working paper, "Credit Debt Puzzle: Liquid Assets to Pay Bills," by Claire Greene, a payments risk expert with the Federal Reserve Bank of Atlanta, and Joanna Stavins, a senior economist and policy adviser with the Boston Fed, that revisits the puzzle.
After running multiple calculations on groups of consumers who pay off credit cards in a timely manner (savers) and those who revolve debt (borrower-savers, or bor-savs), the paper contends the answer to the credit card debt puzzle is that people who revolve debt can't afford to pay their out-of-pocket living expenses in addition to those they put on a credit card.
"Both savers and bor-savs have liquid assets, but while savers have sufficient liquid assets to pay bills and credit card balances, bor-savs do not have enough to pay both," the paper says. "Instead, they pay their bills and revolve their credit card debt because there is a pecking order in payments."
During 2022, the nation's total revolving credit debt rose by $101.5 billion to $1.1876 trillion.
One data point that illustrate these findings is mean annual household income, which for borrower-savers is $75,850 compared with $98,589 for savers, according to the paper. In addition to lower annual household income, borrower-savers are more likely than savers to have faced one or more life-changing events, such as divorce. In addition, they are less likely to have a college degree that could lead to a higher-paying job, and they are more likely to be middle-aged and working rather than over age 65 and retired.
Pandemic savings helped many pay down debt
The paper uses data collected through 2020 to establish that many households were able to pay their expenses with savings accumulated during the pandemic. The proportion of consumers in a sample that paid out-of-pocket living expenses while also revolving debt dropped from 42 percent to 35 percent during the period the paper examines.
Greene and Stavins anticipated consumers would return to using revolving debt as they ran out of other options to pay bills, a consequence of the cost of monthly bills and purchases not declining for households that had stopped using revolving debt. The paper observed, "It is therefore likely that the fraction of consumers who are bor-savs will increase again when the additional savings accumulated during the period of stimulus payments are depleted."
forecast may prove prophetic. Information reported after the paper's release shows that households were flush with cash when they were reducing debt, and some have returned to revolving debt now that the cash or cash equivalents have dwindled.
According to the current report on Personal Saving Rate, issued by the St. Louis Fed, the personal savings rate reached a 60-year high of 33.8 percent of disposable income in April 2020. A FEDS Notes report released in October 2022, "Excess Savings during the COVID-19 Pandemic," showed the nation's total savings reached $2.3 trillion in the third quarter of 2021, which consumers reduced to $1.7 trillion by mid-2022 as pandemic stimulus payments ended and households fell back on earned income and savings to pay bills. " The paper predicted savings would "continue dwindling rapidly."
Consumers increased their credit card usage in 2022. The amount of revolving debt rose by 9.34 percent in 2022. From the first quarter through November, the nation's total revolving credit debt rose by $101.5 billion to $1.1876 trillion, according to calculations of figures in the January 9 release of the November 2022 G.19 statistical release on consumer credit.
Rising interest rates did not deter consumers from accruing debt. The average annual percentage rate for revolving debt reached 19.07 percent in November, up from 14.56 percent at the start of the year, according to the G.19 release.
The credit card debt puzzle likely will continue to be examined, Greene and Stavins conclude. "New data collected in 2021 and later will help address the question of whether the decline in the fraction of bor-savs was transient or is permanent."
David Pendered
Staff writer for Economy Matters