Consumers Paying Down Debt Helps Boost Expansion

(Bloomberg News) Anita Bullock-Morley was $57,000 in debt on 27 credit cards and close to filing for bankruptcy in 2007. With help from an Atlanta counseling service, the 37-year- old says she paid about $1,400 a month and cleared her balances. Now she's used cash to buy an $800 iPad and upgrade her iPhone.

Three-plus years into a recovery from the worst financial crisis since the Great Depression, Americans finally are getting their finances back into shape, Federal Reserve figures show. Household debt as a share of disposable income sank to 113 percent in the second quarter from a record high of 134 percent in 2007 before the recession hit. Debt payments on that basis are the smallest in almost 18 years, while the delinquency rate for credit cards is the lowest since the end of 2008.

"The household deleveraging process is largely over," said Mark Zandi, chief economist at Moody's Analytics Inc. in West Chester, Pennsylvania. "Credit use should soon go from being a significant headwind to the economy to a tailwind."

The progress that consumers have been making will allow gross domestic product to absorb stepped-up deficit reduction by the federal government next year and keep on expanding, Zandi said. He sees GDP growing 2.1 percent in 2013, a bit slower than this year's projected 2.2 percent, as Congress allows some, but not all, of the scheduled year-end tax increases and spending cuts to go ahead. The GDP number will mask stronger growth for the private side of the economy, to 3.6 percent from 3.1 percent, he said.

The improvement will lead to higher valuations for "riskier assets," including U.S. and emerging-market stocks, said James Paulsen, chief investment strategist in Minneapolis for Wells Capital Management, which oversees about $325 billion.

"The financial sector is the biggest beneficiary," Paulsen said, referring to the shares of banks, insurers and investment companies. Their valuations have been based "on a rear-view mirror looking at the past five years and not looking ahead."

Automobile companies -- and their shares -- also stand to benefit as consumers become more willing to buy cars using credit, said Brian Johnson, a senior research analyst in Chicago for Barclays Plc. He's recommending investors overweight the stocks of General Motors Co. and Ford Motor Co. in their portfolios. The former's shares have risen 21 percent so far this year, while the latter's have fallen 6 percent.

The rebuilding of household balance sheets has been helped by a rise in asset prices, particularly equities. The Standard & Poor's 500 Index has climbed 111 percent since hitting a nadir in March 2009. Home prices also are beginning to rise, jumping in the second quarter by the most in more than six years, according to the S&P/Case-Shiller index.

The result: Household net worth as a percentage of income rose to 527 percent in the second quarter from 477 percent in the first three months of 2009, at the height of the financial crisis, according to figures from the Fed. While that's lower than the 652 percent peak hit in 2006, it's higher than the 515 percent average that's prevailed since 1980.

The Fed's easy-money policy -- keeping its benchmark federal funds rate near zero since December 2008 -- also is helping Americans put their finances on firmer footing. Taking advantage of record low mortgage rates, many borrowers are refinancing into shorter-maturity loans so they can pay off their balances more quickly.

"People are opting for faster amortization," said Mike Fratantoni, vice president of research and economics at the Mortgage Bankers Association in Washington.

With refinancing near a three-year high, he reckons that two in five home owners who went through the process in August cut the term of their debt.

Some borrowers are focusing on reducing their payments. Cyrus Cousins, 32, of Austin, Texas, will cut his monthly debt- service costs by about $300 after he refinances into a 3.5 percent mortgage.

"A new car is in the mix for my wife," who drives a 1994 Honda Accord, said Cousins, who works for a coffee wholesaler and retailer. The savings also could contribute to remodeling their 1935 house by adding a second story with an additional bedroom and bathroom and help pay expenses associated with "starting a family," he said.

The recent strength in housing and sales of cars and light- duty trucks suggests that Americans are becoming more comfortable with their finances, according to Wells Fargo's Paulsen.

"We are seeing some big-ticket spending," he said. "They are things you don't see unless you are pretty confident of your balance sheet."

The U.S. economy expanded "modestly" last month, supported by improvements in these two markets, according to the Fed's Beige Book business survey released Oct. 9.

Housing showed "widespread improvement since the last report," according to the Fed, with all 12 of its districts reporting that "existing home sales strengthened, in some cases substantially."

Foreclosure filings fell 16 percent in September from a year earlier to their lowest level since July 2007, according to RealtyTrac, the Irvine, California-based online marketplace for foreclosure properties.

"Stronger housing increases the odds the economy improves" in the fourth quarter, Ed Hyman, chairman of New York-based International Strategy & Investment Group, and his team said in an Oct. 10 report to clients.

New-home starts will increase to 900,000 next year from 750,000 this year as potential buyers become more relaxed about taking on new debt, said David Crowe, chief economist at the National Association of Home Builders in Washington.

U.S. vehicle sales rose last month to a seasonally adjusted annualized rate of 14.9 million, the highest since March 2008, from 14.5 million in August, according to researcher Autodata Corp. in Woodcliff Lake, New Jersey.

Toyota Motor Corp. led with the biggest gain in September, with sales surging 42 percent and topping the 36 percent average estimate of eight analysts surveyed by Bloomberg. Chrysler Group LLC, majority owned by Fiat SpA, and Honda Motor Co. also beat estimates.

"With our current product line-up, record low interest rates and a stable U.S. economy, we remain optimistic," Reid Bigland, head of U.S. sales for Chrysler, said in an Oct. 2 statement.

Deliveries will increase to 15 million next year from 14.4 million in 2012, predicted Barclays' Johnson.

Auto loans to riskier borrowers jumped 14 percent in the second quarter from a year earlier as a wider range of buyers secured credit, according to Experian Automotive, an information-services company based in Schaumburg, Illinois. Lenders remained cautious, though, with average loan-to-value ratios lower than a year ago, Experian said in a report published on Sept. 4.

While lending standards in general have eased, banks are not about to return to the practices they were following in 2005 and 2006 before the housing bubble burst, said Keith Leggett, senior economist at the American Bankers Association, a Washington-based lobbying group.

Consumers such as Atlanta's Bullock-Morley also have broken with the past. The health-care worker says she's "changed my lifestyle"-- she's down to one credit card, has set aside about $500 for a trip to Italy, put money into her personal emergency fund and is saving more for retirement. "I just spend money very differently right now."

Some economists, including Harvard University professor Kenneth Rogoff and former Fed official Nathan Sheets, say the deleveraging process still has years to run. While debt as a share of income has fallen from its peak, the second quarter's 113 percent was above the 94 percent average since 1980.

Sheets, who is now global head of international economics at Citigroup Inc. in New York, said the ratio probably will fall over time to about 100 percent, though he added this can occur without disrupting the economy.

Angela Sasseville, a 37-year-old psychotherapist in Denver, said she and her husband are three years into a "financial turnaround plan" worked out with Community Credit Counseling Services to pay off a five-figure credit-card debt.

"We're not to the end of it yet," said the mother of two. "I do think that folks have to recognize that this is, for a lot of families, not a sprint, it's a marathon."

They've made enough progress that Sasseville and her husband are looking to buy a new, larger home in the spring. "That is something that we are actively planning for and excited about," she said.

That's good news for the economy next year -- and for whoever gets elected president on Nov. 6.

"Private-sector deleveraging is well advanced," said Peter Hooper, chief economist at Deutsche Bank Securities in New York and a former Fed official. The U.S. is "laying the foundation for a reasonably good expansion."