As brother Krugman wrote this AM, “the overhang of debt left behind by the housing bubble…is at the heart of our economic problem.”
So here are two pictures that check in on the status of the problem. Both show progress, but both show deleveraging remains underway, not completed.
The first is total household debt as a share of total after-tax, or disposable, income. First, over the course of the 1990s, the ratio was on an upwards glide path, but the slope accelerates noticeably in the 2000s, when credit got cheaper, risk was severely underpriced, and middle-class incomes were stagnant. That last point is important because it means if you wanted to get ahead, you depended more on your credit card than your paycheck.
Source: Federal Reserve (data include household and non-profit sectors)
Total debt surpassed income (the ratio was greater than one) in 2001, and, as a share of income, grew four times faster in the 2000s (before the bust) than in the 1990s. Post-bust, the ratio reversed course and you see a clear picture of deleveraging in action.
The second picture shows another way of looking at leverage—it’s the share of after-tax income households are spending on servicing their debt—i.e., not the whole debt stock as in Figure 1—just the payments on that stock.
Source: Federal Reserve
This too is coming down and is, in fact, at pre-bubble levels, in part because of low interest rates and, of course, debt write-offs including foreclosures. One might conclude, therefore, that by this measure, households deleveraging cycle is over.
Nope. For that, you’d need to see this decline stop or at least slow down, if not reverse course.
How can policy help to hasten the deleveraging cycle? Jobs and paychecks would help, of course, as it’s a lot easier to pay off your debt if you’ve got some cash flow percolating.
But the Fed could help more too. Another round of quantitative easing might help keep interest rates low (this is where they inject liquidity into the economy by buying longer-term bonds, including mortgage bonds). Also, as economist Ken Rogoff has been stressing, higher inflation, the phantom menace of too many a Fed governor right now, would actually help speed this up, since it reduces the real interest rate (real rate=nominal rate-inflation) and lowers the real value of households’ debt burden.