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The Changing Face of Consumer Finance

Distressed credit markets are changing the look of consumer finance for financial institutions and consumers alike. While the nonmortgage consumer loan assets of commercial banks have grown by roughly 25 percent over the past three years, the recessionary degradation of individuals' creditworthiness and the lack of easy bank financing may slow or halt this trend.

One factor weighing heavily on the supply of consumer credit is the frozen asset-backed securities (ABS) market. Credit cards and student loans (and a fair amount of auto loans) are typically packaged together into a trust by financial institutions, who then sell securities representing ownership interests on the trust to sophisticated investors. In the recent past, ABS issuance allowed banks to extend a great deal of credit since the securities were often not kept on their balance sheets, freeing up additional money to lend. Following the credit panic of mid-September and its roots in residential mortgage securities, investors have fled all ABSs, putting substantial pressure on a major source of consumer loan funds.

As the chart below shows, the issuance of new consumer ABSs all but dried up in the fourth quarter. Securities backed by credit cards have not been issued since September, and no new student loan securities have been sold since August. As a result, risk-aversion by banks and investors is affecting the supply of credit that individuals use to finance large purchases (automobiles and higher education) and for monthly cash management (credit cards).

Consumer ABS Issuance

Similarly, the repricing of risk in the ABS market has sent rates on outstanding securities significantly higher relative to most other asset classes. To help unfreeze the market for consumer credit, the Federal Reserve Board announced on November 25 that it will create a facility - the Term Asset-Backed Securities Loan Facility (TALF) - that will lend to purchasers of AAA-rated credit card, auto, SBA, and student loan securities. The announcement immediately arrested the run-up of rates on credit card and auto ABSs, though the facility will not be operational until early 2009. Consumer ABS rates remain 6-8 percentage points above those of 10-year Treasury securities, though other ABS rates are considerably higher.

Asset-Backed Security Rates

Meanwhile, consumers themselves have changed their saving and borrowing habits in response to both the shortage of credit and economic conditions generally. First, they have begun saving a larger portion of their income. A steep rise in savings in June reflects the economic stimulus package enacted in early 2008. Then, following the events of mid-September, individuals decreased consumption (an almost unprecedented change in trend) and increased personal savings, which had previously been about zero.

Banks' Consumer Loan Assets

Consumers haven't completely retreated from the debtor role, however. Amid the uncertainty of September, home equity loans increased dramatically. This might have occurred if, for example, consumers foresaw a tightening of the economy and credit going forward, and consequently preferred to hold their homes' equity value in cash for transactional purposes.

Savings and Consumption

The flight to safety away from securities and into cash is evident when looking at commercial banks' deposits in the last few months as well. Depositors have added more than half a trillion dollars to their accounts since September and have shown a marked shift out of extended time deposits, preferring to hold more of their savings in more readily accessible vehicles like traditional savings and checking accounts. Banks had a hand in the move to deposits as well: In the absence of interbank and capital market funding, larger commercial banks aggressively priced interest rates to lure new deposits, a more stable source of funding.

Commercial Bank Deposits

In short, the events of the third and fourth quarters have been accompanied by an extreme aversion to risky assets, which in turn has begun to change the dynamics of the consumer credit market. Asset-backed securities have fallen heavily out of favor, with issuance in important sectors of the market (like credit cards and student loans) disappearing altogether. However, the Federal Reserve's TALF program has been announced in an effort to return these markets to functionality.

Consumers have hunkered down as well, boosting their cash savings, avoiding deposit investments with long durations, and when necessary, extracting the equity from their homes to make purchases that consumer installment loans may have funded in the past. It is far too early to judge the likelihood that these trends represent a long-term shift to higher savings versus merely being the necessary reconfigurations in an environment with credit scarcity and rapidly declining personal wealth (due to falling asset values). What is clear is that at a time of widespread illiquidity in numerous asset classes, consumers are rapidly acting to make their own financial position as liquid as possible.

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