Executive Summary

Americans are racking up their credit cards, to make up for the shortfall in their wages.   They've bought homes beyond their means on temporary low interest rates, and borrowed money against those homes for luxuries and living expenses.  Now the home ATM machine is shutting down.  Americans are cutting back on luxuries, but they cannot cut back on food and gas. 

My theory is:  living expenses that were once financed by home equity, are now financed by credit cards. 

My question:  What happens to these families, and to our economy, when the credit cards run out?

 Report

US consumers are running out of money.   As predicted by many of us, falling house prices would lead to less mortgage equity withdrawal (MEW), and thus lower spending.  That's exactly what is happening.  People are unable to use home equity for new cars and vacations, and we see a drop in consumer spending.  Auto sales fell among all the manufacturers.  It's not just a GM problem.  Sales fell among several large retailers, and Tweeters went out of business.  It's not just a Walmart problem.   A sales manager at a big drug store chain told me today that sales have been falling in the past 6 months, and theft is way up.  While I was chatting with her, we spotted another theft item:  an empty box of hair coloring.   If you don't have the money, just steal it.

At the same time that spending is down, credit card use is up.  Peter Schiff, author of Crash Proof, writes:

This week we received new data that illustrates how big of a financial hole U.S. consumers are digging. Despite disappointing sales from major retailers such as Target and Circuit City, first-quarter profits at MasterCard surged 70% to a record $214.9 million following a 19% jump in transactions.

Why is credit card use rising while retail sales and MEW is falling?  Studies on MEW are scant, and not even Alan Greenspan knows where the MEW money is spent.  But many economists believe it was used to fund spending on remodels, new cars, paying off other debt, and luxuries.  I also think it was used for living expenses like medical bills, food, gas, insurance, and property taxes.  Some it went into investing in the stock market or real estate. Again, no surveys or studies have been done on this topic, and Barry Ritholtz recently held a debate about this topic, where he basically lost because he could offer no proof that MEW boosted spending.   However, I am in the camp that has seen MEW used for remodels by almost everyone I know, and looking through people's tax assessor records, I find few whose mortgages stayed constant during the housing boom.  Money was taken out for something, that's a fact.

Another part of the picture is the job losses.  The official data does not show all the losses in construction, lending, and real estate.  Nor does it show that many new jobs are part time and have no benefits.   

So we have these facts, and wonder if they are related

• MEW is shrinking
• Retail sales down for autos, Circuit City, Target, Tweeters, Sears
  
• Credit card use is rising:  Master Card profit up 70%
  
• Job picture is worse:  rising unemployment, new hires often part time and fewer benefits
  

My theory is that the debt-laden American consumer is racking up more credit card debts ever since home values started falling, because they need credit cards to do what MEW used to do for them:  give them the cash needed to pay for basic costs of living like food, gas, medical bills, toiletries, car repairs, etc.

I made the wrong assumption earlier, that MEW was used only for frills:  remodels, cars, vacation, tuition, big TVs, and a one-time payment of credit cards.  I now realize that MEW was used to pay the mortgage, and to repeatedly pay off credit cards, which contained frills as well as necessities.  A realtor told me that people who repeatedly refinance their house use the cash-out they receive at each stage to make their mortgage payment and to pay off their credit cards.   Several mortgage brokers told me that people use MEW to pay off credit cards, and then run up their cards again, so they need the MEW to pay for whatever went on those cards.  So the people got into a cycle:  they used their credit card to pay for gas, groceries, or your kids' dance lessons, and then took a cash-out refinance to pay off that credit card.

I wonder if more people are turning to credit cards to pay their April property taxes.  Does that explain the surge in Master Card profits?  The San Diego County Assessor accepts Visa and MasterCard, with a 1.88% fee (which is probably the fee the card company charges).  The surge in MasterCard profits could be from people using MasterCard to pay their property taxes.  I wonder if the credit card companies release data on what people are buying, or if they sell it for big bucks?  Too bad so many did not set aside money for their annual taxes, which were due on April 15 in San Diego (check here to see if your neighbor paid his).

MEW-fueled spending on big-ticket items like kitchen remodels, furniture, new cars, and big screen TVs is being reduced, while credit-card-fueled spending on food, gas, and perhaps property taxes is staying constant.  Result:   remodeling down, retail down, and credit card use up.

As long as people can service their credit card debt, they will continue funding their living expenses on debt.  However, there is a reason that MEW was used to pay off credit cards:  the minimum payments and interest rates are high, and the limits are low.  Soon, these credit card dependent people will be stuck, as they cannot pay off their credit cards and reach their debt limits.  Then what?
 
Does anyone have any other theories about the falling retail sales, rising credit card use, and falling MEW?