The Coming Turn in Consumer Credit (Fortune, 1956)

by Gilbert Burck and Sanford Parker

Consumer short-term debt, perhaps the most controversial force in the booming U.S. economy, is approaching a historical turning point. Having risen at an abnormally fast rate for ten years, it must soon adjust itself to the nation’s capacity for going in hock, which is not limitless. Whether the rate of growth in consumer debt will slow down is no longer the question; as this article will demonstrate, it must slow down. The question is when it will slow down, and how. There are, to oversimplify only a little, three ways that the decline can occur:

1. Debt growth (not debt itself) may coast downward so smoothly and gradually that the whole turn will be virtually painless.

2. Debt growth may slow down erratically, with painful effects for those industries–notably automobiles, appliances, TV, and all their suppliers–that have received the biggest stimulus from the abnormal rise in debt. For the economy as a whole, however, these consequences might be offset by growth and expansion in other industries, and the transition to a lower rate of debt growth could pass off without serious damage.

3. Finally, however, there is the possibility that debt may continue for a time to mount furiously, until it has reached a level where it has heavily overloaded consumers with fixed debt payments and overexpanded the industries depending on these consumers. Then it could go into an abrupt decline, and it this happened at a juncture when other critical components of the economy were turning downward, the turn in consumer credit would powerfully accelerate a general recession.

The headlong spenders

Consumer debt, clearly enough, creates worrisome economic problems, and to some theorists it still presents a considerable moral problem. Roger Babson once wrote a book called The Folly of Installment Buying, which covered most of the angles, moral and economic. Yet even Mr. Babson admitted that consumer short-term debt is not a theory but a reality, and a durably and quintessentially American reality to boot. As foreign observers from Tocqueville on have noticed, Americans, unlike Europeans, care not so much for money as money as for what money will buy them; and unlike Europeans they exhibit, in the words of Emerson, an “uncalculated, headlong expenditure.” This has made them the world’s greatest consumers; it has helped make the American market the most expansive and dynamic the world has ever seen.

The American genius for consumption has also made Americans the world’s most ardent debtors. But consumer debt in the U.S. is not confined to people who have spent their whole income in agreeable consumption and then find themselves strapped for cash in a sudden emergency. Indeed, the distinguishing mark of American consumer debt is that it carries no broad connotations of emergency or of irresponsibility: it is a respectable arrangement by which many millions of people live, for considerable periods of time, “beyond their means.” Because automobiles and the other consumer durables that serve and embellish the U.S. living standard are expensive, and call for what might be called a capital outlay, a large majority of Americans have let others finance these goods for them.

It is sometimes argued, indeed, that since World War II, installment debt, incurred as it has been in large measure by young couples with children, has offset the savings of the older and more affluent, and so helped prevent a recession. Whether it did or not, there are certainly sound reasons why consumer debt can rise at a somewhat faster rate than the nation’s real income without seriously imbalancing the economy. Durables like automatic laundries and appliances have almost eliminated part-time help, autos have cut down carfare; time payments on these durables thus replace some of the operating expenses of former days. What is more important, the low-income groups are constantly graduating into the middle-income groups, whose consumption of expensive durables is high. This movement in itself would justify a considerable part of the postwar growth in consumer debt.

However beneficent some of the past effects of consumer debt, and however plausible the justifications for some of the recent increase, the fact remains that the recent rate of increase is too high to be sustained indefinitely. Inevitably there will come a time when the economy must be deprived of the extraordinary stimulus it got from the soaring growth of debt in the past few years.

When repayments catch up

An excellent short-term example of what happens when consumer debt expands too fast is afforded by what is happening in the U.S. right now. Last year American consumers, mainly because they bought (mostly on easy credit) two million more cars than they bought in 1954, increased their debt outstanding by $6 billion–from $30 billion to $36 billion–and thus added $6 billion to the economy’s buying power.

But debt, alas, must be repaid, and short-term debt soon. Repayments are rising and will continue to rise. In part because of the unprecedented credit expansion last year, auto sales are declining this year by one million or more units, and debt incurred is, of course, declining with them. At the same time, repayments are advancing sharply and catching up with new debt, and savings–since short-term debt repayments are a form of savings–are rising too. Thus consumer debt outstanding will increase little, if at all, in 1956, and this will deprive the economy of a whopping $6 billion worth of buying power it had in 1955. As FORTUNE’s Roundup has shown, this reduction will be a major factor in bringing about a slight contraction in total business activity this year. Were this reduction not offset by expanding factors like the boom in capital goods, it would exert a much more serious and depressing effect.

What concerns us here, however, is not merely the current fluctuation in debt but its long-term trend, which has been steadily and sharply upward. As the charts on page 100 show, consumer short-term debt has been increasing somewhat faster than the nation’s disposable income over the whole period since 1923, when detailed figures were first available. But during the past ten years, while disposable income rose at an average of 6 per cent a year, consumer debt rose at an average of 20 per cent a year. That is why President Eisenhower’s recent Economic Report expressed anxiety about consumer debt, and suggested a congressional study of consumer credit controls. That is why all sophisticated economists, and many responsible bankers and businessmen, particularly those with accurate knowledge of the 1920’s, are disturbed. The tendency to abuse consumer credit in boom times, as Allan Sproul, president of the Federal Reserve Bank of New York, recently warned, “is a process that cannot go on indefinitely. There will come a time when repayment of old debt will catch up with new extensions of credit.”

When credit goes on a real binge, too many millions of dollars worth of assets are put into production, too many thousands of people are employed, and too many billions of dollars worth of sales are generated, so to speak, ahead of time. Every extreme acceleration breeds an opposite if not equal deceleration. When the binge tapers off, as taper off it must, so do sales, employment, and asset use, with their deceleration intensified by debt repayment. A mere decline in the rate of debt increase can, as a matter of fact, result in an actual decline in production.

Credit crazy

The bald, unadorned figures of consumer-credit expansion smell of a credit binge. The number of U.S. spending units–families and individuals living alone–has increased from 51,200,000 in 1948 to nearly 55 million today, or by 7 per cent. But the total number of debtors has risen 65 per cent, increasing from 22 million in 1948 to more than 36 million. More than two-thirds of all spending units are now burdened with short-term debt. Their total debt has much more than doubled, increasing from $14.4 billion in 1948 to $36 billion, with $6 billion of the increase occurring in 1955 alone. As shown in the chart spread (pages 100-101), all Americans today may be divided into two parts–a declining minority that owes no installment debt and whose liquid assets are rising steeply, and a large and growing majority whose debt is increasing arid whose liquid assets are on the average, actually declining.

And the human trends behind the figures suggest even more strongly a credit binge. During World War II, rationing and high incomes not only generated extraordinarily high savings but caused consumer short-term debt to drop from 11.5 per cent of disposable money income (in 1940, the high till then) to 3.7 per cent in 1944, the lowest level since records were kept. Despite the vast accumulation of savings, however, debt, as a percentage of disposable income, began to rise at a precipitous rate almost as soon as the war ended. Then as now, the evidence shows, the rise was led by young, middle-income couples with children–the returned G.I.’s and other families in the vanguard of the great migration to the suburbs.

They and many others like them fell into installment debt in a natural, almost a routine, fashion. Debt no longer bore the cachet of irresponsibility and poverty. Great sales organizations and consumer-finance companies, ensconced in buildings as reassuring as the Federal Reserve and directed by men resembling loan sharks no more than bishops resemble loan sharks, were underwriting or directly extending credit to consumers. The most stately banks, having wised up to the profits in consumer credit, were condescending to fill the fiscal wants of the common man.

As the prosperous years rolled on, there seemed little necessity to get out of debt. Pension plans, social security, health insurance, and the spreading belief that the government could be depended on never to let another depression occur–all these seemed to eliminate the need for much net balance. So more and more consumers, possessed by a kind of mass compulsion to lose not a month in living up to a community standard, found it easy to regard short-term debt as corporate managers regard it–as a way of acquiring capital goods whose immediate use is worth more to them than the carrying charges.

In their urge to enjoy today the living standard they might be earning tomorrow, some consumers doubtless take on debt with their eyes completely open to its cost. But the evidence overwhelmingly suggests that more and more of them have grown indifferent to the real arithmetic of debt: to the fact, for instance, that a consumer willing to wait for a new car until he can pay cash for it can buy a TV set on his interest savings. They usually do not even ask how much the luxury of short-term postponement is costing them. Nor have they been restrained by many authoritative voices; those who should know better have sung all too indiscriminately the glories of debt extension.

The fact is that the $28 billion in installment debt this year will cost consumers more than $4 billion in carrying and interest charges, or about 16 per cent on the balance over the year. This is a big price for lower and middle-income groups to pay for the luxury of postponing the reckoning a little.

Mortgage on wheels

Now let us examine in more detail the kind of debt U.S. consumers have taken on, and see how loaded up they are. Only 23 per cent of the $36 billion outstanding is noninstallment debt, such as charge accounts, doctor and hospital bills, and single-payment loans. Noninstallment debt has been growing only moderately fast, rising from $3.2 billion at the end of 1945 to $5.4 billion at the end of 1948 and to $8.3 billion at the end of 1955.

The bulk of the increase in consumer debt is accounted for by installment debt, which has risen from an abnormally low figure of $2.5 billion at the end of 1945 to $9 billion at the end of 1948, and to no less than $28 billion at the end of 1955. And the major factor in the rise of installment debt, accounting for over half the debt outstanding and nearly half the number of debtors today, is the automobile.

Borrowing from the future

Automobile paper outstanding has risen from $455 million at the end of 1945 to $3.1 billion at the end of 1948 and to no less than $14.3 billion at the end of 1955 (or 360 per cent since 1948). The proportion of cars bought on time has risen from 40 to more than 70 per cent. Cars alone accounted for nearly $4 billion of 1955’s $6 billion rise in consumer credit.

To a considerable extent, auto credit has been responsible for the fluctuations in auto sales. If the industry makes cars that are unusually hot one year, it is likely to sell an unusual number of them and to some extent “borrow” from future sales. And if credit terms are relaxed to boot, the hot cars are endowed with a double appeal, which makes next year’s models all the harder to sell. This is what happened in 1955. The 1956 models are selling at a rate of about 6,250,000 cars a year–a lot of cars, certainly, but well below the 7,400,000 sold last year. The 1956 models not only embody fewer innovations than the 1955 models, they are confronting a market that bought heavily last year on credit terms that had been relaxed both in down payments and in maturities.

One of the wistful hopes of economists has been that consumer credit could be employed as a countercyclical force–i.e., that terms could be tightened up when times are good, relaxed when times are not so good. In practice, however, consumer credit behaves in just the opposite way. When times are good, auto dealers, for example, push sales with every device they can, especially relaxed credit terms; when times aren’t so good, dealers are forced to tighten up terms because their customers are less attractive risks, and of course the odds for delinquency rise sharply after bad risks are taken on easy terms. And when times aren’t so good, used-car prices decline abnormally, and the risk of loss increases.

Even for the paper of the large auto-finance companies, whose debtors are better than average risks, the average maturity has gone up about 20 per cent in two years from about twenty-four to nearly twenty-nine months. Since many debtors still prefer to pay off their debt in say, eighteen months, many others obviously are getting six, nine, and even twelve months longer than they got in 1953. One eastern banker says that 60 per cent of his auto paper was written for a thirty-six-month term. Surveys by FORTUNE late in 1955 and early in 1956 showed that dealers were usually willing to give thirty-six months; many were allowing forty months or more.

How relaxed can you get?

As for down payments, most statistics are distorted by the fact that they include inflated allowance for trade-ins. But surveys by FORTUNE and others show that dealers almost everywhere are willing to take as little as 15 per cent cash (with no trade-in), and some were offering to help a prospect borrow the down payment from a loan company.

This grand relaxation of terms brought a lot of second-car buyers and new low-income buyers into the 1955 market, and to some extent this may have expanded the market permanently. But it also brought in a lot of buyers, so to speak, ahead of time, and so borrowed customers from the 1956 and even 1957 markets. Whether still more customers can be borrowed depends on whether terms can be relaxed much more. One of the many surprising things about auto credit is that the debt outstanding on cars sold with even a sizable down payment is greater than the cars’ wholesale value for months after the sale. When a car is sold on a 25-per-cent down-thirty-six-months-to-pay basis, for example, the buyer’s equity in the car does not catch up with the wholesale value for about twenty months. Such circumstances are worrying many dealers. All that stands between them and repossession at a loss is the fact that Americans want cars badly, and have the money and the resolution to pay for them.

Automobile debt is not the only kind of installment debt that has been rising much faster than disposable income. Other forms of installment debt have risen from $5.9 billion in 1948 to $13.6 billion, or by 130 per cent. These forms are (1) housing repair and modernization loans, (2) “other consumer paper,” and (3) personal loans.

Repair and modernization loans have nearly doubled, rising from $843 million at the end of 1948 to more than $1.6 billion.

More important is “other consumer paper,” which is offered by retail outlets and which has more than doubled, rising from a little less than $2.8 billion at the end of 1948 to about $6.4 billion. Among the most significant developments in this category is the growth of retail interest-bearing credit in department stores. Almost the whole department-store industry is now actively pushing interest-bearing debt, and is soft-pedaling charge-account debt.

Other retail outlets are in the act. In 1928 less than 5 per cent of Sears, Roebuck’s retail sales volume was made on time; in 1941 the percentage was 28; today it is 41–on $3.5 billion of sales. How much of Sears’ net is derived from installment-interest charges Sears does not say.

One of the hottest “innovations” (though apparently it dates back to 1935) is the interest-bearing charge account known as the revolving credit account. The store extends, say, a $240 line of credit to a customer, who obligates himself to pay $20 a month on the outstanding balance, plus a “service charge” of 1 to 1.5 per cent a month. Canny operators describe the plan as chiefly a device to increase sales, but candid ones admit that the interest charge is a juicy source of profit. The scheme has put soft goods on the installment plan in a big way.

Finally, among the major forms of installment debt, there are personal cash loans, which have increased from $2.2 billion at the end of 1948 to $5.5 billion, or by 150 per cent. About 40 per cent of the loans are made by small-loan or “consumer-finance” companies, more than a third by banks, and the rest by credit unions and others. In the thirty-eight states where small-loan companies are supervised, they have some ten million borrowers.

“The valley of debt”

Whether or not many consumers are, technically speaking, “pyramiding,” the evidence mounts that they have begun to pile debt on debt to a significant degree. Many, having got extended terms from auto dealers, are taking advantage of the lower monthly payments to go in hock for appliances or furniture, or to buy soft goods on revolving credit. As a matter of fact, some seem to be borrowing cash to make down or time payments on expensive durables like autos.

That more and more people are having trouble with repayments is argued by the spectacular rise of some 300-odd credit-counseling companies, which help debtors get themselves straightened out, for a good fee. Some counselors are shady operators, under the interdiction of Chambers of Commerce and Better Business Bureaus, but some appear’ to be honest and functional; and good or not so good, so many could not exist if a growing body of debtors were not in trouble.

The largest debt-consulting company, before it got into trouble, was New York’s two-year-old Silver Shield, which, for a fee of 15 per cent of a “hopelessly” indebted man’s outstanding debt, helped him to escape from his “Valley of Debt.” Silver Shield’s average client owed money to no fewer than ten creditors, and some owed to as many as forty-five. This astounding circumstance is explained by the fact that banks and loan companies do not exchange information because they don’t want to reveal the names of their customers to competitors, and by the fact that most application forms have little space under the item “other creditors.”

“And what’s a guy going to do when he sees that?” asks one heavily hocked debtor. “Ask for another form?”

Not enough non-debtors

Such are the dimensions and the most significant characteristics of the huge increase in short-term consumer debt in the past seven years. Why, to come to the most critical question of all, can’t it go on increasing this way?

Installment debt has, as we have seen, risen from $9 billion in 1948 to nearly $28 billion. Auto paper has risen much more sharply than other installment debt, from $3.1 billion to $14.3 billion. Thus installment debt outstanding has grown from 5 per cent of consumers’ disposable money income in 1948 to 10.9 per cent in 1955. If this rate of increase were to continue another seven years, installment debt outstanding would have to rise to about 17 per cent of disposable income in 1962. How it can is hard to see.

For the rise in total installment debt was a compound of two factors: (1) the number of installment debtors increased from 19 million in 1948 to 35 million in 1955, or by 85 per cent; and (2) average debt per debtor rose from $475 to $800.

First of all, the number of debtors cannot rise over the next seven years as it has over the past seven. As the chart on page 100 shows, the proportion of debtors is already extremely high precisely at the income levels that would have to account for any future increase: 78 per cent at the $3,500 level, 81 per cent at the $4,500 level, 76 per cent at the $6,000 level–an average of close to 80 per cent, compared to about 48 per cent in 1948.

For all practical purposes, these percentages are pushing their limits. There are, and always will be, some people even at these income levels who don’t have to incur installment debt and don’t want to. And there is little chance that the non-debtors in either the lowest or top income groups will join the army of debtors in sufficient numbers to swell the ranks very much. The former can’t afford to, and as the chart on page 101 shows, in the upper-income group, which accounts for most of the non-debtors, people are growing steadily more liquid.

But let us extravagantly assume that the proportion of debtors in the middle-income groups can rise from 80 to 90 per cent, and so generate four million more debtors by 1962. There will also be four million more spending units seven years from now than there are today, and perhaps 2,500,000 of them can be expected to go in debt. And because more families will be moving up from the low-debt-low-income brackets, perhaps 1,500,000 additional debtors will come into being. This adds up to eight million more debtors–a rise in the next seven years of at most 23 per cent in the number of debtors, against an 85 per cent rise in the past seven.

A nation of fifty-percenters?

Which leaves only one way the past rate of debt growth could be sustained: installment debt per debtor must increase much faster than it has increased in the past seven years. This would put an intolerable burden on consumers. Let us look, for example, at what would have to happen to the spending units in the $3,000 to $7,500 groups, which would have to account for most of the rise. The average debt outstanding in these groups is nearly 15 per cent of the debtor’s disposable money income. If the national consumer debt is to go on rising as it has been, his indebtedness would have to increase to more than 20 per cent of his disposable income. Can he elevate his debt this much?

The only way to tell is to look at the average consumer’s obligations. The charts on page 101 show that the nation now funnels 30 per cent of its disposable money income into fixed payments–13 per cent on installment payments and the other 17 per cent on other fixed housing payments. The debtors in the $3,000 to $7,500 groups, however, spend on the average 40 per cent of their disposable income on fixed payments–17 per cent on installment payments and 23 per cent on other fixed payments. And no fewer than 25 per cent of these middle-income debtors spend more than 50 per cent of their disposable income on fixed payments—more than 20 per cent on installment payments and the rest on other fixed payments. Since these spend another 25 per cent of their budget on food, they obviously are carrying all the fixed payments they can.

If, then, the debtors in these middle groups were to increase their installment debt outstanding to more than 20 per cent of their disposable income, they would have to funnel fully 23 per cent of their disposable income into installment payments. That is, nearly all debtors in these middle groups would be funneling 50 per cent of their disposable income into fixed payments.

For all practical purposes, debt probably will have reached its peak long before fixed payments rise this high. Debt growth, in short, will almost certainly turn down before seven years are up.

Deteriorated assets

The distortion of consumer budgets by debt pretty well disposes of the frequently advanced argument that debt can be expanded because debtors’ short-term asset position has improved greatly–that the $30-odd billion worth of cars and other durables they own has offset their debt rise.

Actually, the short-term asset position of debtors (liquid plus durable assets minus debt) has not kept pace with their incomes, which have risen 31 per cent since 1948. It has not only failed to keep pace, it has apparently declined a little. For in their optimism, debtors have let their liquid-asset position deteriorate markedly. As the chart on page 101 shows, the average debtor’s per capita liquid assets have declined from $1,800 in 1948 to about $1,600 in 1955, even while his debt per capita was rising from $475 to nearly $800. These figures, moreover, tend to overstate debtors’ liquidity because their asset figure is swollen by the circumstance that some people with high liquid assets do occasionally buy something on time.

What will happen to the economy in dollars of purchasing power can be estimated roughly. If installment debt were to rise at the rate it has been rising over the past seven years, it would, as we have seen, increase from its present 10.9 per cent of disposable income, or $28 billion, to nearly 17 per cent of an enlarged disposable income, or about $56 billion. But this, as we have also seen, is a virtual impossibility. A reasonable figure, FORTUNE estimates (from the long-term growth in debt-income ratio), is about $42 billion. In the next seven years, in other words, installment debt should rise no more than an average of $2 billion a year, or $2 billion a year less than if it continued to rise at its recent rate. And the ‘economy will get a proportionately smaller stimulus from the rise than it got in the past seven years.

This letdown obviously presents no great problem if the debt growth tapers off gradually. And even if it slows down erratically, to repeat, the pain may well be confined to a few industries like automobiles and appliances. The rest of the economy, if other industries are expanding, may hardly notice it.

Binge’s end

But the habit of taking on more debt is one of the economic forces that do not readily slow down of their own accord, and it would be naive to underestimate the possibility that debt could continue to mount precipitously in 1957 and 1958. Relaxation of terms has, as we have seen, not yet reached its theoretical outer limits. More and more consumers, prodded by their endless wants as well as by easier terms, could postpone maturities further and further, push the average indebtedness closer to the maximum, and finally hock themselves to capacity to consolidate their debts. All of a sudden, so to speak, the day would come when a significant body of debtors would find themselves boxed in by their own fixed payments, unable to respond to the lure of relaxed terms–indeed to any lures. The credit binge would come to an end, and the industries depending on it would be hard hit.

What would happen then, once again, would depend on the rest of the economy. If house construction, the capital-goods industry, commercial construction, and others were starting or already in the throes of a readjustment of their own, a general recession would be hard to avoid. If, on the other hand, other industries were rising, the drop would be well cushioned.

As for government’s role, the rate of debt increase is now beginning to slow down, and there is no case for any immediate action; tightening credit terms right now, indeed, would be just what the economy doesn’t need. If, on the other hand, debt should pick up and take off again in 1957, some kind of braking action might be necessary. Meantime, as the President’s Economic Report has recommended, both Congress and the Council of Economic Advisers would do well to keep watch on the nation’s phenomenal urge to borrow.

Data for this article were prepared under FORTUNE’S direction by Alan Greenspan of Townsend-Greenspan & Co. Basic aggregate credit data before 1929 came from a variety of sources, since 1929 from Federal Reserve Board. Postwar distribution of aggregates from data collected by University of Michigan’s Survey Research Center; prewar distribution from data by BLS and Department of Agriculture. Fixed payments aggregates from data of Federal Reserve, Department of Commerce, Institute of Life Insurance, etc.; distribution of fixed payments from data of the Survey Research Center.