Household De-leveraging: Light at the End of the Tunnel
By Rom Badilla, CFA – Bondsquawk.com
Despite massive amounts of federal and monetary stimulus and much to the chagrin of policy makers, the recovery following the financial crisis has been lackluster with modest gains in economic growth and in job creation. Consumer spending, which comprises close to seventy percent of GDP, has failed to capture its former glory of the boom as households continue to repair balance sheet and pay down debt. This deleveraging up to this point has been holding back consumption and in turn has been a headwind for economic growth. Going forward, this should no longer be the case.
Deutsche Bank economists, Brett Ryan and Joseph LaVorgna, stated that the U.S. deleveraging cycle is past the midway point which suggests that the recent gains in household debt profiles should be a positive development for the U.S. economy going forward. In their latest U.S. Economics Weekly, they wrote the following:
To be sure, this deleveraging has likely had a depressing effect on the pace of economic activity. Over the past few years, the economy has grown at about half of its historical pace of 4% annualized real GDP growth. Household debt as a percentage of nominal GDP peaked at 97.5% in Q2 2009 and in absolute dollar terms, household debt peaked in Q1 2008 at $13.8 trillion. Since then, debt outstanding in this sector has declined -6.3% (-$880 billion) and at 83% it now stands at its lowest share of GDP since Q4 2003 (82.9%). This marked the early stage of massive debt expansion. In fact, debt has increased in two out of the last three quarters. Clearly, households have made significant progress in making necessary balance sheet repairs. Provided that income growth improves, households may actually begin to modestly increase their absolute amount of debt.
In addition, they wrote that debt in proportion to other measures should continue to decline and may in fact reach more “normal” levels within the next few years assuming modest assumptions.
If we assume the current average pace of household deleveraging (approximately -0.1% per quarter over the past four quarters), and assume approximately 4.0% nominal GDP growth over the next two years, household debt to GDP would intersect its long-term trend line by Q2 2014. As an aside, the story is broadly similar when comparing household debt to gross disposable income. This ratio has declined from a peak of 125% in Q2 2007 to 106% as of Q2 2012—the lowest level since Q2 2003 (105%). Again, this is a dramatic improvement, returning the level of household debt to income back near pre-credit bubble readings.
The latest Retail Sales figures support that the consumer is gaining traction and is spending again. This contrasts with signs that Business Investment which is another integral component in economic growth, is declining as the uncertainty surrounding the Fiscal Cliff approaches. It remains to be seen if the consumer follows suit in anticipation of the potential for the higher tax burden. Having said this, it is apparent that beyond the short-term, consumers will be less encumbered by balance sheet repair given the strides made in debt reduction over the past several years. Coupled with improving conditions in credit and the rebound in housing, consumer spending could provide the tailwind toward better economic growth in the months and years ahead.
35 Comments
The problem is that the fall (in household debt as % of GDP) is unlikely to stop at the trendline. what we are likely to see is a dip below the trendline of roughly equal magnitude to the 2008 peak.
DB does realize that trendline means nothing, right? I mean, it can’t go up forever so to assume that it means any important is just stupid.
Agree with SS. The debt to GDP ratio can’t keep going up forever. It will probably trend way below toward the end of the decade then maybe stabilize, hopefully.
Depends on interest rates, I figure. The big upward trend in debt/GDP, from ’83 to ’08, was while consumer interest rates were generally falling.
trendline, regression…the story is clearly here but we could well correct below trend line in a 64/74 fashion (i.e. we could only be halfway before it reexpands)…so need to maitain govt stimulus to close out until 2018 (or more since steep seems to decrease) then…then stop govt spending which will be a deflationnary force….
Of course it can keep going up, the only constraint is debt servicing cost as a percentage of disposable income and potential asset quality
I did not know, that non-profits were considered household..
Exactly my thoughts. What the heck does “non-profit” outstanding debt have to do with this series and premise?
Has anyone measured it this way to reach this conclusion?
I suspect a tendentious conclusion is being sought here. Let’s see the series purely for households as others have said.
Does it really matter how the deleveraging occurs? I mean, isn’t that like complaining that the mortality rate is too high and then saying that most people commit suicide so their deaths don’t count. I don’t see why people try to downplay the deleveraging just because people are being defaulted on. Who cares ultimately? It’s a debt problem whether you choose to pay it down or whether someone chooses to pay it down for you….
I would argue there is a sizable difference between the regular, orderly payment on debts owed and outright default. While both count as “deleveraging,” only the former allows the consumer to maintain a credit rating which translates into the ability to increase their debt. Defaulting on a mortgage, or credit card, has future negative implications on the ability of a consumer to spend and thus should not be ignored.
DC, brilliant retort!
Cullen,
I have no problem with the fact that households are deleveraging. I have a problem when someone uses a dataset that includes a component – nonprofits – that I have never heard of or seen before. Why are non-profits on an equivalent footing to households?
This extra dataset impacts the regression, the slope of the line and therefore the ultimate conclusion. Look at the sources footnote. Who could possibly confirm data from all these sources?
Since we are talking about households why not just use household figures?
Sorry if I wasn’t clear in my initial point. The point would have been better made using the cleanest dataset.
“Does it really matter how the deleveraging occurs?”
In that case, all that needs to be provided is a simply headline…
“America’s mortality rate reaches record highs.” I mean, you know, that more people are dying…Details, hell no!
Who cares ultimately?
When the dust finally settles where is the money/credit (easy credit circa mid 2000′s) going to come from to get the machine moving again? There are way too many moving parts to be dogmatic regarding where this de-leveraging will ultimately lead. Couple all this with D.C,’s deficit hysteria and we have a recipe for one hell of a mess that could well make the 08 meltdown look like a walk in the park, de-leveraging or no de-leveraging.
I have two objections to this analysis.
1) It is total wealth of the households that probably determines the hit to spending (debt is one part of the liability side of the equation). Wealth went from 100% of GDP to 150% and then down to 50%. If house prices increase, for example,the debt will seem more bearable.
2)Wealth as % of GDP is a much more stable series since 1950 instead of debt. So one does not need to make this silly trend assumption on where debt should be. The long run average US households lived with was 100% of GDP. They got into a 50% hole (7.5trln USD or so). And recovering. The hole is bigger measured this way. Twice as big as this debt makes it out to be. But crucially, the trend assumption is the key. Without the trend, it might go back to 60% of GDP (pre bubble level) which would give a similar magnitude of adjustment as my wealth analysis.
Net net, I think the magnitude of adjustment that deleveragign and saving needs to fill is bigger than is made out here. 1.5x to 2x. And therefore it will take 1.5 to 2 times as long.
They are making this claim on the basis of 4% nominal GDP growth in 2013 and 2014?!? In the face of all the data both here and abroad, we will be lucky to have .5% growth in 2013 alone.
Mr Badilla, has good this deleveraging only half right, just like the owner of this website, Mr Roche…
Most of the deleveraging is due to default…
http://business.time.com/2012/10/19/household-debt-has-fallen-to-2006-levels-but-not-because-were-more-frugal/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+timeblogs%2Fcurious_capitalist+%28TIME%3A+Business%29
Why “half right”? Deleveraging is deleveraging.
I don’t understand why people nitpick on this, particularly when CR isn’t making any big claims based on what type of deleveraging we’re seeing.
The important thing is that household debt get under control, and whether it’s by defaults or “normal” frugality isn’t that important.
Windchaser, we are not nitpicking…
Most of the folks deleveraging, will not be entering the market soon, as major consumers, as their credit has been badly degraded…
What does that mean? It means that much of the reminder of consumers have not restructured their debt enough to be able to advance spending, short of expanding their debt load..
The average homehold is still burden by too much debt and can do little to propel the economy..
Frugality is in short supply…
Deleveraging by default is often the only solutioon. Or do you think that the fruit picker in California that received a $750,000 mortgage will be able to pay off the debt from his $15,000 annual income?
Deleveraging by default is a good thing; in fact, it should be our policy. And I think that homeowners should incrase their ‘tactical defaults’.
Not to rain on the parade, however, but two uncomfortable facts:
1. Just because a man defaults does not necessarily increase his spending. He loses his house but now he still has to pay rent somewhere, right?
2. We grew the economy in the 00′s by living beyond our means. The inference is that if we can clear up our debt we can go back to living beyond our means?
Well stated, Mr Evers!
“2. We grew the economy in the 00′s by living beyond our means. The inference is that if we can clear up our debt we can go back to living beyond our means?”
That’s purely a financial concept. In real terms we made more stuff prior to the meltdown. So now that we have millions of people sitting idle are we living within our means?
It was one member hear, who indicated that loan write off were responsible for deleveraging…
http://prudentinvestornewsletters.blogspot.com/2012/10/quote-of-day-myth-of-deleveraging.html
“Deleveraging” = Foreclosures and bankruptcies.
Do some research, these two factors make up the majority of “deleveraging” going on.
So what, it’s still relieving the private sector debt overhang.
The problem is the trend line is upward.
Debt as a percent of GDP should not be increasing.
Looking at increasing trendline for Debt as % of GDP is nonsensical. This shouldn’t be a trendline model, instead should be a balance-line model. What is a healthy level for the times – call it the balance-line (zero) and debt could yo-yo above and below this level. Levels can increase or decrease according to times. The reason levels could increase:
1) People live longer and retire later, thus can take bigger loans as % of GDP (proxy for income)
2) Political stability has been reached in a chaotic region, thus enabling bigger debts to be offered because chances of collection have increased.
In the above two cases the healthy-debt level can have a one time increase. In other cases it should stay parallel to the ground.
I tend to agree, however, take a look at this similar chart from Steve Keen (1st chart on the page):
http://www.debtdeflation.com/blogs/manifesto/
At the end of WWII, public (gov) debt to GDP was at an all time high (understandable, as we just paid for WWII on credit), and private debt to GDP was at an all time low (understandable after some 15 years of deleveraging — I think 1929 to 1933 counts as deleveraging too, even though the ratio climbed, because what actually happened here was the denominator (GDP) plummeted!). But then look at what happened from 1945 to 1975… a steady CLIMB in private debt levels (the public debt from its all time record high in 1945 was easily paid off in about 10 years, BTW) corresponding with some pretty good decades of economic growth!
Keen’s theory is that expanding debt levels ADD to aggregate demand (AD). After reading his famous debate with Krugman, and the evaluation of it by several 3rd parties, I don’t think Keen and Krugman define AD the same way… but Keen makes a good argument for his definition. During deleveraging, using Keen’s AD definition, contraction of debt subtracts from AD, which intensifies the pain of the recession (beyond what traditional AD measures would indicate).
So while I agree with you about the merits of targeting a level trend line (to avoid booms and busts), the end of WWII set us up for a LONG period of expanding debt levels (perhaps the Great Depression and WWII set us up for this by giving us the “headroom” for it) which may have ultimately had a big impact on the economic success of those years.
This made me think that perhaps Keen’s “modern debt Jubilee” idea that he advocates as a quicker way to get us out of our current recession (basically the gov cuts everyone a check w/ the proviso that if you’re in debt you have to use it to pay it down) might be worth institutionalizing (if it really works that is) to occur on a regular basis (every three decades or so). Other “debt Jubilee” advocates and anthropologist David Graeber claim that is exactly what happened in ancient Sumer, Babylonia, Israel, and (I think) Egypt: They had regular (every 50 years or so) debt jubilees, to wipe the slates clean, because, apparently, debt peons make terrible soldiers. They point out is was easier back them because most debts were to the palace or the temples.
So, making the BIG assumption that this idea (jubilee and modified AD definition) has some merits, I wonder if this regular jubilee idea combined with in between times of steady credit expansion might actually be the best overall way to go. I have no idea how that could be made to work in a practical way. But what I’m imagining is a saw tooth shaped private debt level… long slow steady climbs, interspersed with abrupt fall offs (when the gov forgives/pays-down everyone’s debt).
That way during the slow steady climbs in private debt levels, recessions would be short and not require much help from the gov, since there’d still be plenty of “headroom” for private debt levels to climb (out of the recessions with). Thoughts?
Looking at the chart again, I guess you could argue that the “long slow steady climb” in private debt levels (and thus the “good times”) extended well into the 2000s… however, I wonder if at some point (the 1980s perhaps) we started to do some real damage (like de-industrializing our nation and transferring political influence from industry to finance).
Cullen, I’m trying to square this article with what has become one of my favorite charts that Steve Keen maintains on his site:
The 1st chart on this page:
http://www.debtdeflation.com/blogs/manifesto/
I really like that Keen’s goes back to 1920 and includes a curve for “public debt” as a ratio of GDP for comparison. The problem I have is that the numbers don’t seem to agree with the chart here. Keen shows this most recent “balance sheet recession” as having peaked at 303% of GDP, and that it’s now descended to about 260%. Comparing with 1933, it looks like we’re in WORSE shape regarding the private debt level. I also like how it shows deleveraging continuing right on through to the end of WWII while government spending kicks up a notch in 1941 (for obvious reasons) and continues to climb until public debt was in even WORSE shape in 1945 than it is today (again as a % of GDP). That’s when the magic happens on Keen’s chart: All that deleveraging (some 12 or 13 years of it) in the private sector, combined with a SERIOUS government deficit spending spree, set us up for some 30 years of unprecedented growth! (I realize that’s an oversimplified take on the matter and that surely there are a lot of other important factors… but if you consider that the newly debt forgiven LOSERS of WWII (Japan and Germany) also had unprecedented growth in this period, having WON THE WAR isn’t necessarily amongst them!).
Anyway, I keep going back to Keen’s chart because I think it’s really illuminating… but is there some reason I shouldn’t trust it???
Why do you suppose the charts are different?
(BTW, I also have another issue: the text here says “Household debt as a percentage of nominal GDP peaked at 97.5% in Q2 2009″ but the chart is labeled as “GDP” not “NGDP”… another mismatch… is the chart really NGDP?)
BTW, I believe David Stockman’s (verbal) assessment of our PRIVATE debt levels is more in agreement with Keen than the author here. I’ve heard him say numbers like $60 or $55 Trillion COMBINED public/private debt (depending on what year he was interviewed). If public debt is on the order of $15 or $16 trillion, that seems to agree with Keen’s chart.
I remember back in the 80′s people who made the same money I did started buying things with borrowed money that I wouldn’t dared to have bought. “I’ll just try to hang on and hope for the best it’s how you get ahead” they would say. The idea that people would just start drinking the debt koolaid already- like that would be a great idea -is scary stupid. 2003 levels are ridiculous. We need something more like ’83. Things got crazy after that. I’ll admit I don’t know what the optimal level of household debt is but I’ll bet it isn’t found in the 2000′s.
I’ve found household debt as a percentage of income to be a more reliable indicator of future demand and household spending.
Households are the core of the financial crisis. And most of their recovery has been through write downs. And most of that has been in the area of housing.
Oh – that’s right – the housing market is returning to health (just like a patient in a hospital that is on a feeding tube is returning to health)!
Mid-1960s – early 1980s this trend also decreased – due to high interest rates.
Oh – that’s right – interest rates are going to continue to drop for many years. They have no where to go except up!