Last week, we told you about the rising level of subprime auto loan delinquencies.

Well, there is a similar thing happening in the subprime credit card market.

Is this the proverbial canary in a coal mine?

Balances more than 30-days delinquent on credit cards issued by the roughly 4,500 banks smaller than the top-100 surged to 7.05% in the fourth quarter of 2019, according to the latest data released by the Federal Reserve. That’s the highest delinquency rate in this category going all the way back to the 1980s.

But the delinquency rate for credit cards issued by the 100 biggest banks was a historically low 2.48%. This pushed the overall delinquency rate to 2.7%. That’s the highest level since 2012.

To make sense out of what’s going on here, you have to understand how the credit card market works. Generally, the bigger banks issue cards to the most credit-worthy borrowers. There are people with higher incomes and good credit scores. That leaves the subprime market to the smaller banks. In order to compete with the bigger banks, small financial institutions need to take on greater risk to build their credit base. As a result, delinquency rates tend to run higher for these small-bank credit cards.

Issuing credit to subprime borrowers is risky, but it comes with a big reward. Interest rates can run as high as 25 to 30%. Even if the bank has to write off a higher level of these credit card loans, they are still profitable overall. On top of that, banks can mitigate their risks by securitizing these subprime credit-card loans into asset-backed securities. This is exactly what lenders did with subprime mortgages in the years leading up to the 2008 financial crisis.

The rising subprime delinquency levels in both credit cards and auto loans indicates there is trouble brewing at the bottom end of the economic scale. What’s particularly disturbing is the fact that this is happening when the overall economy is supposedly booming. As WolfStreet pointed out, in the aftermath of the 2008 crash, credit card and auto loan delinquencies were soaring because over 10 million people had lost their jobs and they couldn’t make their payments.

“But these are the good times – with the unemployment rate near historic lows. And yet, there are these skyrocketing delinquency rates in the subprime subset of credit cards and auto loans. It means these people are working, and they’re falling behind their debts.”

Consumer debt is at record levels. Americans owe nearly $1.1 trillion in credit card debt alone. But over the last several months (the holiday Christmas shopping season notwithstanding) borrowing has been slowing down. This could indicate that consumers are tapped out. Rising delinquency levels in the subprime market are another sign of trouble.

This is not good news for an economy that is built on spending money we don’t’ have. The consumer spending binge that drove what little GDP growth we’ve seen over the last several years hasn’t been funded by surging incomes at the lower 60% of the wage scale. In fact, we’ve generally seen real wage stagnation. Borrowing – particularly via credit cards and auto loans – has driven the spending spree. And now we’re seeing both the auto loan and credit card markets rotting at the margins.

Inflation is another factor dragging on lower-income Americans. While the official CPI is relatively low, prices are in fact rising.

This is causing what WolfStreet calls a “bifurcation” in the economy.  Higher income earners are still doing OK. They’re enjoying the windfalls of rising stock prices and artificially low interest rates. But everything isn’t so bright.

“There are other consumers whose incomes have not budged much – maybe it went up in line with CPI, but CPI doesn’t reflect actual price increases of cars and homes and other items. Everything big they’re trying to buy or rent or use has soared in price – new and used vehicles, housing, healthcare, education, etc. And those consumers, though they’re working hard, are getting squeezed. That’s the bifurcation. These are the people that are strung out. They have jobs but are living from paycheck to paycheck, and not because they’re splurging but because, at their level of the economy, prices of basic goods and services have run away from them.”

The question is how long until this cancer creeps deeper into the economy?



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