WASHINGTON – American households have been slashing their savings and taking on increasing amounts of debt, putting many in a weaker position to weather an economic downturn that has grown all the more likely after the recent turmoil in the banking sector.
Fears of a slowing economy were renewed this week as US regulators seized Silicon Valley Bank, Swiss officials stepped in to shore up Credit Suisse’s finances and a group of Wall Street firms threw a lifeline to First Republic Bank.
The events drew parallels with the 2008 financial crisis and are likely to prompt banks to tighten their lending, putting further pressure on already strained consumers, which in turn could cause them to pull back on spending and trigger layoffs at businesses that is facing declining sales.
“What we are seeing right now, in terms of stress in the banking sector, is likely to have a compounding effect on the deterioration of household finances,” said Gregory Daco, chief economist at EY-Parthenon. “We are likely to see an environment where banks are more cautious with their lending, particularly smaller regional banks, and that will further exacerbate the softening that we have already seen.”
Goldman Sachs on Thursday increased its odds of a recession by 10 percentage points to 35%. Other economists are even less optimistic that the US will be able to avoid an economic slowdown, with those surveyed by Bloomberg putting the odds of a recession at 60%.
Over the past year, when inflation has hit its highest level in decades, consumers have largely been able to keep increasing their spending. While retail sales fell slightly in February compared with January, they were still up 5.4% from a year earlier, the Commerce Department reported this week.
Bank of America credit and debit card data from February showed that consumption per household income rose 2.7% year-over-year, which “suggests to us that consumer spending remains robust even as the rate of growth in spending slows,” according to a report last week from the Bank of America Institute.
But data indicates that wages have not kept pace with inflation over that period. As a result, Americans have increasingly turned to their credit cards and savings accounts to keep up with their spending habits.
“The average person’s finances were probably better off a year or two ago than they are now, just because they were more liquid with cash and had less debt,” said Ted Rossman, a senior industry analyst at Bankrate.com. “There was a time in early ’21 when credit card balances were 17% lower than before the pandemic. And now they’re up 28% from that low point.”
Americans have spent about half of the savings they accumulated during the pandemic, from about $2.1 trillion in excess savings from the influx of government stimulus checks and reduced spending during lockdowns to about $900 billion in the third quarter of last year, according to a report by JP Morgan.
At the same time, the percentage of people’s paychecks going into savings has fallen to about half of what it was before the pandemic, according to data from the Federal Reserve Bank of St. Louis.
Meanwhile, the amount of debt Americans carry has increased. Credit card balances rose by $61 billion to a record high of $986 billion in the final quarter of 2022 — a sharp turnaround from two years ago, when Americans paid down debt with stimulus checks, according to data from the New York Federal Reserve. Auto loan balances increased by $94 billion.
There are signs that an increasing number of consumers have found it more difficult to pay off that debt.
The share of credit card holders who carry month-to-month debt has risen to 46%, up from 39% a year ago, according to Bankrate. Auto loan defaults are steadily rising from their pandemic lows, with the share of auto loans at least 60 days delinquent at the highest level since 2006, according to a report from Cox Automotive last month.
All of these factors have investors, economists and business leaders closely watching what moves the Federal Reserve will make on interest rates next week. Another round of interest rate hikes would make it more expensive for consumers to borrow money to finance a home or buy a car or to carry a balance on their credit cards. It will also put pressure on companies that want to borrow money.
But with persistently high inflation — up 6% in February from a year earlier — some economists say the Federal Reserve has no choice but to keep raising interest rates to curb spending.
Another key factor that economists say they are watching is the labor market, which has remained strong in part because consumers have held back their spending.
Job creation slowed in February but was still stronger than expected, with the economy adding 311,000 jobs, the Labor Department reported last week. The unemployment rate rose to 3.6%, relatively in line with where it has been for the past year. But even a small increase in unemployment could cause millions of Americans to pull back on their spending.
“The backbone of consumption activity is the labor market,” said Daco, the economist. “If the labor market begins to show more significant signs of cooling, moderation, is weakened, then that will have a direct effect on household incomes and in turn on their ability and willingness to spend.”