Digging bigger holes

This week we received new data that illustrates how big of a financial hole U.S. consumers are digging. Despite disappointing sales from major retailers such as Target and Circuit City, first-quarter profits at MasterCard surged 70% to a record $214.9 million following a 19% jump in transactions. I see two possible explanations for this apparent paradox. The first is that despite buying fewer items, consumers were forced to borrow to pay for things that until recently they could afford to pay for in cash. A second possibility is that due to disappearing home equity and tighter lending standards, fewer home owners were able to tap into home equity and were thus forced to use credit cards instead. Since credit card debt carries higher interest rates and is non-tax deductible, it is far more expensive to finance then mortgage debt. Under either possibility, future consumption will suffer as an even greater share of personal income is devoted to making interest and principal payments on items consumed in the past.

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