Grade Inflation

Last July we wrote a piece called Interesting Interest which touched on the state of consumer debt and the effect rising rates might have.   Now, nine months later many of the things predicted in that post have come true.  In February consumer debt officially climbed to over $4 trillion; with credit card debt increasing by $41 billion between November and December to a whopping $1.03 trillion.  That coupled with the interest rate hikes saw credit card interest payments climb about $13 billion from 2017 to a total of $113.3 billion. Despite all of that, on the surface it appears that everything is still in pretty good shape.  According to the Federal Reserve, mortgage and credit card delinquency rates are still 2% below where they were in 2008.  On the other hand, auto loan delinquency has continued to trend upward nearing all-time highs.  Now what does this mean?  Well in a recent piece by Bloomberg, Adam Tempkin dives into how “grade inflation” might be causing this disparity.

According to Moody’s and Goldman Sach’s analysts and economists, credit scores have been artificially inflated over the past decade.  This means that consumers are likely riskier than their credit scores would lead you to believe.  They opine that the metrics used to calculate credit scores haven’t accounted for the arguably the longest recovery in history and could be misrepresenting some consumers ability to pay their bills when the inevitable slow down comes.  As an example of this grade inflation, Moody’s estimates there are 15 million more consumers with credit scores above 740 and 15 million less with scores under 660.  Taking it one step further Cris deRitis deputy chief economist at Moody’s Analytics goes on to say, “You might have thought 700 was a good score, but now it’s just average.” 

So, when you break it all down, grade inflation and the percentage of debt to disposable income reaching record highs for consumers (which isn’t calculated in credit scores) could bring unexpected pain when the economy does slow.   Alas much of this is outside of our control, so the only real course of action is to make sure you are living within your means.  Personal debt isn’t always a bad thing and if you ever want us to help determine to if it is the right move for you please don’t hesitate to reach out.

All the best,
Wesley R. Nicholson, Mike Allen and Aaron Everdyke