Chart of the day, consumer credit edition

By Felix Salmon
September 22, 2010
Lending Club emails me the data for this chart:

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Joe Toms of Lending Club emails me the data for this chart:

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Joe comments:

Consumer credit has been the one area that has dropped the least. Said in a nice way, this points to the structural inefficiency. A more blunt assessment is that banks have been taking advantage of consumers.

The picture is certainly striking: consumer credit rates, as measured by the Federal Reserve, fell by just 3.74 points over the period in question, while Treasuries and corporate debt dropped in yield by over 10 points. Even munis saw a much more striking fall in rates, despite the fact that their tax advantages were seriously eroded as tax rates fell.

Part of what’s going on here, of course, is that the consumer-credit universe became much less creditworthy as banks started giving out credit cards to anybody and everybody. But that’s not the whole story. We’re also seeing a move from relatively low-interest-rate personal loans to relatively high-interest-rate credit cards. And, of course, we’re seeing huge profit margins, at the banks, on consumer credit: the banks in general have done a very good job of competing on everything except lending rates.

The result is a gap in the market for innovative new online companies like Lending Club and BankSimple, all of whom in one way or another are looking to profit from those high consumer-lending rates. Given that they’ve stayed stubbornly high for the past 30 years, it’s probably fair to assume they’ll stay high for the foreseeable future.

Update: There was an error in the original chart: I’d labeled the Mortgages as Aaa bonds. Fixed now. Why were mortgages more expensive than consumer credit in 1981? I’m not sure, but it’s probably something to do with negative convexity and prepayment risk, as well as the fact that they’re much further out the yield curve.

8 comments

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ummm…don’t you think the case is more that rates were artificially low in 1980? almost every state had usury laws back then that capped rates at low levels. do you really think that it is appropriate that an individual in 1980 could borrow essentially unsecured on a credit card with a lower rate than an investment grade corporate?

Posted by kwijibo | Report as abusive

Ahh, Felix, Felix. Now I haven’t looked at the data, but for a minute I am going to assume that the sample is 3 year Aaa/Baa bonds (1), so what you actually are looking at here is a tightening spread vs. Treasuries of about 33 bps on Aaa and a /widening/ credit spread of 235 bps on the Baa bonds. Consumer credit has clearly not fared well (+949 vs. Treasuries), but this graph is misleading at best.

(1) Which is clearly not the case, b/c give me a Aaa 3-year w/ a 4.9% yield right now and I will buy that all day and lever it up.

Posted by quantacide | Report as abusive

That’s a somewhat misleading chart in that it doesn’t, for instance, show the interest rate for unsecured bank liabilities.

Posted by GingerYellow | Report as abusive

“And, of course, we’re seeing huge profit margins, at the banks, on consumer credit…”

Oh yeah, that’s why so many investors are rushing to set up new mono-line credit card companies. Because of the huge, low-risk profits to be garnered. All the large issuers have been incredibly thrilled by the huge margins in this business since about mid-2007….

Posted by TRKAdvisors | Report as abusive

Isn’t it relevant that with mortgages, bonds, etc. the interest rate is always paid whereas with a revolving consumer credit line, those who pay it off every month aren’t affected by that APR? This means that those with the best credit – i.e. those who run no balance – are effectively not in the market at all and thus have no downward pressure on interest rates.
I have a credit card with 15% APR which is irrelevant because I pay it off each month. If they forced me to take the money and pay interest, I’d demand a lower rate or not take it. I’m not sure these things are comparable.

Posted by JesseB | Report as abusive

“The picture is certainly striking: consumer credit rates, … fell by just 3.74 points over the period in question, while Treasuries and corporate debt dropped in yield by over 10 points.”

Yes, consumer rates today stand out as high, but then treasuries stand out as low. To me the longitudinal comparison is more striking than the cross-sectional. Credit spreads were thin across the board in ’81, whereas nominal rates were uniformly high. Now we have minuscule base rates and fat spreads. The story in ’81 was high nominal rates and low price of credit risk, the story today the opposite. Just look at how munis have inverted to treasuries.

Posted by Greycap | Report as abusive

Weren’t credit cards still in their nascency in 1981? Held primarily by the wealthy? I’m not sure that is a fair comparison to the average rates today.

Posted by TFF | Report as abusive

 A lot of long-term context is missing in the comments posted so far.  It is vitally important to note that the financial system was very different in 1981.  A huge wave of change was about to unfold over the next 30 years.   Bad credit has been extended throughout man’s history.  If you repeatedly finance there will be mistakes.  The more germane point is that starting in the early 1980’s we began to systematically develop sophisticated ways of providing easy credit to a broad spectrum of poor borrowers in a much larger way.   Over time the absurdity of this was demonstrated by the ARM, no interest pay-as –you-go loan.  The whole financial system levered up and all major fixed income categories (with limited exception) witnessed a large decline in aggregate credit quality.  It is what has led us to the mess we are dealing with today.  Yet, interest rates have plunged throughout this period.  Spreads however, as one comment mentioned, are wider.  Why have rates plunged and spreads widened?  The first question is harder to answer as there must be many factors involved.  A huge shift in Western demographics (baby-boomers of all cultures producing excessive savings), central bank, government and corporate policies have clearly contributed.  The second part is of the question is easy.  Spreads should be wider reflecting the a wider range of credit quality spawned by this evolution!   Finally, a number of statements reflect the misperceptions surrounding consumer credit.  The first association in most people minds with consumer credit is sub-prime.  Yes, just like mortgages and sovereign government bonds, consumer credit quality has deteriorated as it expanded.  You can buy poor mortgages, Greek bonds, or sub-prime consumer credit.  But the broad brush statement that the market is risky is far from the truth.  Unsecured consumer credit (credit cards) is a huge market, approximately $850 billion.  The higher credit quality bands have had a long, consistent history of reliably paying throughout recessions, including the last one.  These people are not sub-prime but yet still pay rates that do not reflect the changes in interest rates over the past 30 years.  Why?  To generate a return on consumer credit you must aggregate enough loans to be reasonably certain of the financial outcome.  The only ones who can are financial companies.   The result is little competition and not surprisingly higher rates.  A number of other factors also come into play.  Nonetheless, the central point is that it’s a uncompetitive market place with the result that rates have remained stubbornly high.

Posted by jtoms | Report as abusive