Credit Card Charge-offs Could Reach 8%-10%

Yesterday, CNBC reported:

Soaring U.S. unemployment and a shrinking economy drove delinquencies on credit card debt and home equity loans to all-time highs in the first quarter as a record number of cash-strapped consumers fell behind on their bills.

The latest data indicate that credit card charge-offs, which stood at 7.49% in the First Quarter of 2009 will likely rise further.



Moreover, if the experience with the previous two recessions is reasonably representative, a peak quarterly charge-off rate of 8% to 10% is possible.

If one examines the experience with the past two recessions, one finds the following:

• The quarterly credit card charge-off rate reached a higher peak in the 2001 recession than the 1990-91 recession, despite a milder contraction in peak-to-trough real GDP.

• The quarterly credit card charge-off rate peaked 4 quarters after the 1990-91 recession ended and 1 quarter after the 2001 recession concluded. The 1990-91 recession was triggered, in part, by a housing bust that encompassed 1989-1994. Considering that the current recession was precipitated by the collapse of a massive housing bubble, a delayed peak akin to the 1990-91 recession is probably more likely than not.

• The amount of personal-sector debt relative to personal-sector liquid assets at the start of a recession appears to have some bearing on the magnitude of the peak credit card charge-off rate. Personal-sector indebtedness relative to liquid assets was markedly higher in 2001 than in 1990. In other words, declining credit quality likely explains the higher peak charge-off rate for the 2001 recession, even as the loss of economic output was markedly smaller than during the 1990-91 recession.

• The amount of personal-sector debt relative to total personal-sector assets mattered less. The need for liquidity and reality that non-liquid assets are difficult to convert into cash during financial market turmoil possibly helps explain the apparently weaker link tying personal-sector debt with total personal-sector assets than the relationship of personal-sector debt with personal sector liquid assets.



That the current recession is the worst of the post-World War II period with a 3.1% decline in real GDP through the First Quarter and the unemployment rate has reached 9.5%, which is well above the peak figures for the 1990-91 and 2001 recessions, argues for a higher quarterly peak charge-off rate than occurred during either of those earlier recessions. Even worse, the ongoing recession unfolded at a time when the personal sector had even higher debt relative to its liquid assets than it did during either of the previous two recessions. As a result, the quarterly credit card charge-off rate is likely to continue to climb in coming months and a peak figure in the 8% to 10% range is likely.

In turn, that development will add to the stresses currently impacting the nation’s weakened financial system. Those additional stresses could culminate in numerous additional bank failures. In addition, increased financial system fragility could lead to a delayed and/or slower and weaker rebound in economic growth than would otherwise be the case.

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