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Which Bills Should I Pay? How Consumer Priorities are Changing

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As the present economic crisis continues to unfold, some noteworthy changes in consumer behavior have started to emerge.  One with far-reaching consequences for credit unions is the increasing tendency for consumers to forgo paying for their mortgages while choosing to pay credit card bills.  Between first quarter 2008 and third quarter 2009, the percentage of consumers who were current on their credit cards while delinquent on their mortgages rose from 4.3% to 6.6%.  During the same time period, those who were current on their mortgages while behind on their credit cards dropped from 4.1% to 3.6%.  (Forget the Mortgage, I’m Paying my Credit Card Bill, usnews.com, 2/8/2010)

A variety of reasons are driving this behavior including the fact that it takes much longer to foreclose on a home than it does to shut down a credit card.  Unemployed consumers may need the credit card more acutely since it can pay for daily necessities while the home foreclosure is months down the road.

Although unemployment is the major cause of mortgage defaults, strategic defaults – where consumers who can afford their payments choose to walk away for financial reasons – may be driving some of this behavior change, too.  Brent White, a University of Arizona law professor, makes a thorough argument in favor of choosing strategic default.  Setting aside the complicated moral questions, if more voices like his are heard, could this become the new socially acceptable norm?

What does it mean in terms of projections for loan losses and new loan volumes?  How will underwriting standards change going forward?  Will a consumer who suffered long-term unemployment and lost a home be given a “pass?”  What about one who chose a strategic default?  It is important to consider these shifts in consumer behavior when doing financial and strategic planning recognizing the good, the bad and the ugly emerging trends.

(White, Brent T., Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis, Updated February 2010)

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10 Reasons Things Went Wrong… Has Anything Really Changed?

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For years, we have been emphasizing a list of 10 reasons (not in order of priority) risks are not appropriately managed in the financial services industry.  Many of these reasons contributed to the volatile economic environment we find ourselves in today.

  1. Mindset—We can take action when bad things happen so things will never be as bad as risk simulations are showing—forgetting that the point at which we address a problem is directly related to the number of viable options we have for solving it
  2. Decision-makers don’t agree on appetite for risk
  3. Decision-makers agree on appetite for risk but don’t make the tough decisions to manage within their appetite
  4. Decision-makers take on more risk than they are truly comfortable taking because “everyone else is doing it”— so it must be right…
  5. Lack of effective communication between decision-makers and risk quantifiers
  6. Short-term decision making
  7. Decision-makers not linking strategy and A/LM (financial structure management)
  8. Contingency plans are not tested to determine if they are adequate
  9. Using old decision drivers and measures of success in a new environment—following peers
  10. Improper risk quantification providing a false sense of security

Click here to view the expanded version…

Recent history has shown us the havoc caused by inadequate risk management, and we are concerned that the havoc will continue or worsen if something doesn’t change.

Many in the financial services industry continue to worry over tightening margins, threats to non-interest income, diminished loan growth—the list goes on.  However, we urge all stakeholders to consider the long-term viability of their credit union rather than rely on short-term decision making (#6).

We are seeing more and more credit unions focus on short-term “Band-Aids” instead of taking a longer-term view of making sustainable changes to the way they do business.  Short-term solutions often come with long-term consequences—some of which could be another cycle of credit losses, assessments or even renewed stabilization efforts.

There are no easy, quick fixes for the financial services industry.  The situation requires a thorough evaluation of the sustainability of current business models and, most likely, redefining measures of success.

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Lacking Consumer Confidence and Lending

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In spite of recent signs that the economy may be turning around—including a 0.3% increase in real consumer spending in January to the highest level since May 2008—consumers still don’t seem to be buying a strong recovery.  February’s present situation index, which serves as an indication of how consumers are feeling with regard to the economy, hit a 27-year low (not since 1983) of 19.4 (Consumer Confidence Tumbles in February, CNNMoney.com, 2/23/10).

The lack of consumer faith in the economy can be seen across the lending landscape:

  • Banks in the U. S. posted their sharpest decline in lending since 1942 as of year-end 2009, dropping about 7.4%  (Lending Falls at Epic Pace, The Wall Street Journal, 2/24/10).  Credit unions experienced only modest loan growth of about 1% according to the NCUA
  • In the 4th quarter 2009, revolving consumer credit decreased at an annual rate of 13% (Federal Reserve Statistical Release G.19, 2/5/10).  In January, the trend continued as consumer credit dropped for the 11th straight month
  • With regard to mortgage lending, existing home sales dropped 17.7% in December 2009.  Even with the extension of the government homebuyer tax credit, existing home sales dropped again in January another 7.2% to a 7-month low (Existing Home Sales Fall, Market Watch, 2/26/10)

It appears consumers are feeling even worse than when the economic collapse was in motion and that the “economic recovery” is still shaky.  How soon can credit unions expect a sustainable increase in their members’ loan appetite?  What can be done in the interim?  It is essential for credit unions to continue to focus on what they can control and to perform in-depth evaluations of their business models—making appropriate changes, timely.