Debt Update

August 15th, 2011 at 8:41 am

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.


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12 comments in reply to "Debt Update"

  1. comma1 says:

    A program to consolidate student loan debt might help too. The collapse of the bubble meant that a lot, if not all, of the student loan consolidation companies vanished over night. As such, people who borrowed for school and graduated near when the bubble burst have been unable to take advantage of the lower interest rates that homeowners have been able to take advantage of. This is an entirely new phenomenon since the bursting of the bubble. Prior to that burst recent graduates could get multiple offers to consolidate student loan debt each week. Yes, I said each week.

    To state the obvious, consolidating at vastly lower interest rates could greatly reduce payments and help fix the Debt/Service line further. I would imagine that separating out the different types of debt will find a large increase in student loan debt over the past decade, because some were trying to escape the Bush jobless-recovery even prior to the bubble burst, and certainly a large number of people went back to school to wait out our present circumstances too. Let’s not forget, we haven’t had any real job creation in almost a decade.

  2. Geoff Freedman says:

    This again, for me seems spot on. The amount of debt also hits on one other issue somewhat indirectly, and that is wealth distribution in this country. Most folks net worth is based on their housing values, and housing prices cratered in 2008. Plus folks have been using credit cards and second mortgages to keep up with the Jones’s.

    Between the debt, housing prices devaluation and the very regressive Bush tax cuts, the net worth of the lowest 80% is only 15% of aggregate net worth for the country. There will be no consumptive spending at this level, unless debt is deleveraged. In 2008 Debt to Asset ration was 133%. Its now 118%. At this rate it will be 4-6 years before Debt to Asset ration is 100% (1 to 1).

    I agree with Ken Rogoff. The best stimulus package we could do right now is debt right offs and mortgage reduction. There are some interesting ideas out there to do this.

    This is not a normal recession. It’s more like a huge world wide contraction, just like the 1930’s and we have to look at it differently than a normal cyclical recession. Another of Ken Rogoff’s ideas (among others).

    See a similar point by William Gale in the link listed below to an article written by him.

  3. Andrew Sprung says:

    As a mortgagee, I have wondered from time to time about economists’ claim that inflation lowers my “real interest rate.” It does insofar as my income rises in step with inflation, of course. But Americans’ incomes have been stagnant for a decade, regardless of low but not-nonexistent inflation. If you’re unemployed, or on a fixed income, or not making real gains in income, inflation doesn’t lower your “real interest rate”, does it?

  4. Tyler says:

    Ken Rogoff is a debt hawk, but he’s not as hawkish as, say, Ron Paul.

    I’m not sure why I should have to endure inflation because people bought houses they couldn’t afford, but whatever.

  5. John T says:

    Mr. Bernstein, while I see the rationale behind wanting higher inflation, I think you are missing an important point. While unemployment is high, workers do not have enough power to demand and receive increases to keep up with inflation. Maybe higher inflation would make de-leveraging even more difficult under these circumstances.

  6. marc sobel says:

    I think one thing that may make your charts look more optimistic than reality is that apparently a lot of the credit card debt reduction was banks writing off bad debt. For reasons, I don’t understand, apparently it is harder for a bank to hide bad credit card debt than bad mortgages.

  7. Martha Retallick says:

    I’m with Marc Sobel. I’ve heard that financial institutions are writing off credit card debt at pennies on the dollar.

    Which implies that their strategy of offering credit cards to anyone and everyone who can fog a mirror isn’t a good thing.

    Matter of fact, I can remember a time when credit cards were pretty darn hard to get. That was as recent as the 1980s. Back then, you had to prove that you had a certain income level. And that you had a steady job — or sufficient income from self-employment to justify a card.

    Believe me, it was a lot harder to get the card if you were self-employed. My dad found this out firsthand back in the 1980s. My mother, a public school teacher, had to co-sign his application.

  8. perplexed says:

    I would guess that looking at averages really obscures the picture with regard to consumption effects. Since most (if not all) all of the increase in income has gone to the top 10% (who have very little of the debt) and aren’t likely to change consumption all that much. Looking at the debt/income ratio of those actually constrained by the debt would probably tell a different story about likely increases in consumption.

  9. Misaki says:

    From the last part of this article,

    “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.”

    There are certainly many things that could be done that would have a positive effect for some part of the economy, and what is seen as a negative effect in other parts of it. However generally speaking, there are a much larger number of people who would prefer the US avoid inflation. From on the debt ceiling deal:

    this is a big win for politicians- both Republicans and Democrats. This is a catastrophic loss for taxpayers- both Republicans and Democrats.

    507 votes up, 10 votes down

    if Con is the opposite of Pro, What’s the opposite of Progress?…. Congress

    409 votes up, 8 votes down

    The winners are the debt holders. The losers are the American tax payers. The villains are members of congress who keep spending my money. The heros…where are the heros?

    268 votes up, 5 votes down

    The losers in all of this is the American people. Both parties neither care about this country or us for that matter. It is obviously all about power. We need to clean house in 2012 folks.

    54 votes up, 0 votes down

  10. Jared Bernstein: Rick Perry, Ben Bernanke, and the Middle Class says:

    […] inflation also speeds up the ongoing deleveraging cycle by eroding the real value of households' debt […]

  11. Alan Robinson says:

    There is a chart floating around on the web that breaks down debt between student loans and other categories of consumer debt. The chart shows that all debt other than student loans are declining very rapidly. Student loan debt is rising. My sense is that if you updated your charts by looking at student loans and other consumer debt you would see that those with student debt are the ones currently suffering the most financially. To the extent that they are of the age that they would be starting independent households and families, and buying houses, cars, furnitutre etc, their student debut is causing them to delay independences and purchases that are usually highest among people in their 20’s and thirties.

    What this means is that the consumer economy will not begin to recover until those who graduated from college in the past five years paid off their student debt or see increases in income.

  12. Anon says:

    One of the big things that you economists miss in these pictures is that debt that is “written off” is not “destroyed” – first mortgage debt in non-recourse states and bankruptcy being the exception. It just gets sold off to debt collectors who harass debtors, garnish their wages (effective wage deflation), and sweep in to take any savings they manage to put away.

    Until we have real debt destruction through inflation or some other means, the problem isn’t going away.