Is the Balance Sheet Recession Over?
The Z1 flow of funds report just came out and the debt figures really jumped out at me:
“Debt of the domestic nonfinancial sectors expanded at a seasonally adjusted annual rate of 6½ percent in
the fourth quarter of 2012, 4 percentage points more than in the third quarter.Household debt increased at an annual rate of 2½ percent in the fourth quarter. Home mortgage debt
contracted ¾ percent, continuing the downtrend that commenced in early 2008, while consumer credit
rose at an annual rate of 6½ percent.Nonfinancial business debt rose at an annual rate of 8¾ percent in the fourth quarter, a somewhat faster
pace than in the third quarter. As in recent years, corporate bonds accounted for the largest increase.”
And this doesn’t account for what will be an inevitable rise in mortgage debt (the biggest piece of the pie) in 2013. You’ve gotta start wondering at this point – is the balance sheet recession over? Are households done de-leveraging? It is sure beginning to look that way….
I’ll crunch the sectoral numbers and get back to you….
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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63 Comments
Repeat comment from a few weeks back that never got addressed:
Household debt to GDP in the US was always below 50% until the mid-1980′s, and peaked at around 98% in 2008/2009.
We’re a little north of 80% as of Q3 2012 after massive household deleveraging. Do you think these are sustainable percentages? Do you think there is room for increases beyond the 2008/2009 peak? What is your ideal ratio?
Thanks Cullen.
I don’t use debt to GDP. I use debt to income. That’s come way down and I think it’s sustainable as long as the economy remains stable. Of course, that’s the unpredictable part, but I don’t see recession and slowing in many places yet (which isn’t saying much for a slow economy to begin with). But the move from 115% debt to income down to 95% is a substantial improvement. I’d be uncomfortable if we popped back up to those levels again. So hopefully we continue to see some income improvement.
Good point. If we’re comparing household debt (CMDEBT as tracked by FRED) to income (PINCOME as tracked by FRED), you come up with disturbing trends.
Debt/income for households never peaked above 60% until 1980, and didn’t peak above 80% until 2000.
So it’s really tough to say which ratio is sustainable. Are we still way too leveraged at 95%? Do we need to come back down to 2000 levels?
To me it would be extremely discouraging for this ratio to begin increasing again, and virtually would ensure another (perhaps more devastating) round of private sector deleveraging in the future.
…isn’t that the $3 trillion question! b/c if it isn’t sustainable–
$1 trillion differential down….3 to go
Of course, interest rates also have a considerable impact on the level of “sustainable” debt/income.
Agreed. Household debt service ratios relative to incomes have come down to pre-housing bubble levels, however this is more a function of reduction in rates than writedowns of debt.
Would these ratios increase as a result of Fed rate hikes, or are these lower debt service payments locked in due to refi’s at fixed rates?
if you look at Ray Dalio’s work on deleveraging he basically says people keep leveraging up in a “long cycle” as longs as central banks can keep reducing interest rates to lower the debt servicing burden.
When that can’t happen anymore then you enter deleveraging. I thought we were at that point already and deleveraging would go on a lot longer but Cullen seems to have picked it much better.
What will happen next? Maybe the Fed has been too successful and there will be one more round of leveraging up before a bigger crash where the Fed has no room to ease… Maybe we simply hit a glass ceiling and bounce around up there with low interest rates and correspondingly low expected returns on all other assets for a long time to come…
Which income measurement are you using? I thought GDP was equal to aggregate income.
In a way I feel we have more capacity for debt now because we allocated it (through government deficits) over a more stable base (everyone). I am not making a value judgement, that is just an observation.
Well, I keep it apples to apples when talking about the BSR. The BSR in the USA was a household debt crisis so I use personal income relative to household debt. Keeps the comps on even ground and not apples to oranges. If we use GDP we have to include govt debt which misrepresents the actual problem we had.
Don’t you think the BSR was a bank debt crisis more than a household crisis?
Lehman went broke, Merrill had to be sold, etc., etc. The actions that have been taken by the Fed were meant to save the banking system’s balance sheets, not to rescue the households, imo.
Banks don’t go broke unless their customers are broke.
We’ve disagreed on this before. I think you are fundamentally misrepresenting what happened back in 2008.
A few bank customers went broke, and because the banking system was highly leveraged, that event broke the system.
The idea that the guy in Florida whose house fell in value bankrupted Lehman Brothers is preposterous on its face. Lehman did that to itself with it insane investments.
But that’s why the banks want us to believe, so they can get their balance sheets repaired and go back to business as usual until they blow themselves up again.
It’s only “preposterous on its face” if you ignore the facts. Here are the facts.
See all those surging default lines LEADING the Lehman bros crisis? Lehmand didn’t happen until WELL after the defaults started to spike in 06, 07 and 08. The entire banking business was built on the consumers ability to continually keep the housing bubble alive. And when the consumer bailed the whole house of cards fell.
Yes, the consumer got into trouble. I’m in a credit union that saw default rates higher than those. But we’re still in business and didn’t need government help because our policies allowed us to navigate that enviroment. We didn’t build our business around leveraged MBS and other crap that fell apart the minute the housing market stumbled.
The banks got themselves into a position that when their investments fell by 10 and 20 percent, they lost 100 percent of their capital.
You’re just confirming what he said. Lehman Brothers was leveraged on a house of cards whose base was the consumer. It all started with the consumer whether they leveraged other products or not.
GLG34 — well, yeah, had Lehman not leveraged its capital on housing values, it would still be in business, so yeah, you are agreeing with me.
Values fluctuate, whether its stocks or housing or any investment, and recessions comes around every four or five years. You’d think an investment house would understand that.
Had banks not levered up, would there have been a housing bubble?
Sure, but the banks and brokerages wouldn’t have failed.
I don’t know that I can subscribe to that. I think the causation is backward in your view. The banks provided the credit that led to the inflation in home prices. It was based on the faulty belief that even if the customer defaulted, real estate values don’t go down. And you can’t downplay the magnitude that this was going on. Take a look at the FDIC failed bank list. NONE in 2005 and 2006, ZERO! 3 in 2007, 25 in 2008, 140 in 2009 and it peaked in 2010 with 157 bank failures! I wonder what could have happened during that time period? Eventually these customers defaulted, and they couldn’t sell the properties without taking a loss because prices were too high and you couldn’t even get a loan if you wanted to buy because surprise, surprise, bank credit tightened because defaults were going up and customers had too much debt!
Bank lending is capital constrained, so in order to expand their balance sheets without additional capital, banks themselves “levered up”. It was a risk/return decision. Additionally, to move risk off their balance sheet, they created SIV’s that only spread the risk throughout the system as hedge funds, pensions, etc. invested in these SIVs. That’s what made a many customer defaults lead to a few broke banks lead to a financial crisis.
Joe, we agree on the outline of what happened.
But again, the leverage and the exotic loan instruments magnified the crisis.
As you say, the banks sucked companies like Merrill into the morass. Remember how surprised we were to find out that Merill, which we thought was a brokerage that advised high net worth clients, was really a leveraged play on real estate. Merrill failed because of its own mistakes.
Cullen posted a couple of days ago about an Apple-only hedge fund that failed when Apple’s stock fell. In that case, the manager took the blame … and the loss. We don’t say that the failure was caused by Apple.
You want to blame it all on the banks, but you don’t seem to understand that banks only lever up to make more loans…loans to people or businesses. People are not forced to take those loans.
Ok, but I think the relationship between the household sector and banking sector is a bit more intertwined than a hedge fund and a corporation. I think the bubble was created mutually by the household sector that wanted to stretch a little to have nicer things (remember that commerical, “how do i afford it? I’m in debt up to my eyeballs!)and banks wanted to help these consumers stretch so they could have higher profits and afford nicer things. They didn’t care about long term, bc as we both point out, they shipped it off their balance sheets and into our pension funds and 401(k)s.
In 2005, I was a stupid 24 year old kid, a whole two years of working experience under my belt and a wife that wanted a house. I did not want to do it, I never thought I could afford it, and I’ll never forget her father saying, “you’ll have equity instead of wasting money on rent.” So for 8 months I had “equity” but $0.93 cents in my checking account at the end of each month. Luckily, that wife became my ex-wife and we were able to sell in early 2006 at a small gain, but we know many people didn’t have the same dumbluck I did. And that was the sentiment during that time, consumers thought they couldn’t lose, banks thought they couldn’t lose. So in my opinion it was a household crisis, that caused a banking crisis, which led to a severe recession.
Pierce, Merrill Lynch was not leveraging up to make mortgage loans. Merrill Lynch wasn’t in the mortgage business.
They were leveraging up to buy securitized instruments. THey were betting on the mortgage market and they blew themselves up.
Joe, we’re just going round in circles. If a bank lends me a dollar and I default, the bank is out one dollar. If the bank lends me a dollar and then makes a leveraged play that guarantees it will lose 10 dollars if I default — well, that’s not banking, that’s gambling.
Wow, that was quick! I understood this would be a long hard slog to work our way through these accumulated private sector debt imbalances. I am looking forward to your follow up report.
I shouldn’t imply that the “end” is an event. It’s a process. But I’d say we’re in the 7th inning so….
I think the answer is “yes” without a doubt deleveraging is over…. for now. Low interest rates have brought affordability on homes back to early 1980 levels despite debt to income back to around early 2000′s levels. What this means is the Fed is reinflating the bubble, and as long as interest rates stay low, we could have 1 to 5 years of good times. Since very little structurally has been repaired, it just means in a 2008 style crisis at some point down the road. So good times are here again…. for now.
The one thing that is keeping housing from exploding is loan criteria. One loan officer told me “no way” will criteria even get remotely close to what it was before. However, I’d like someone smarter than me to tell me if this article means she’s likely to be wrong – rise of CDO’s and CLO’s “Signaling a Return to 2004″
http://www.cnbc.com/id/100422439/Remember_CLOs_CDOs_They039re_Back_Signaling_Return_to_2004
If that’s true – look out – we’re just at the begining stages of a new housing led bull/boom. Basically a replay of 2004 to 2008 all over again…. ending in a similar way, no doubt
Good catch, hangemhi.
I don’t see housing as the next bull/boom-it’s still too tainted.
But I DO see subprime corporate securitization as next bubble to invade the investor realm. The comment from the article says it all:
“The German newspaper said the investors – who were all institutional – would receive interest of between 8 percent and 14 percent. ”
Boom…bust…then Fed buying assets to keep a floor so pension funds won’t have to go bankrupted.
Gosh, this news makes me nervous not happy. Look at the component of the debt that is going up – credit card & student loans.
On Mish’s site and on Newsmax last week, they indicated that HH sector income actually went down a few % points.
This sounds sneakily like, ‘I need to buy food, but I don’t have the cash. I’ll put it on my card.’
I hope that this not the case, but getting some D/I numbers would also help.
I will attend the FRED chart of D/I and get where you have to go to get it (which Fed site?), so I don’t bother you again about it.
Anyone else know where to get this FRED D/I chart? Is the the NY Fed site?
whats wrong with non-dischargable, variable rate student debt & credit card debt at 20%+?
Agreed. 1+ trillion in student debt in a tight labor market does not seem like an sustainable credit growth channel.
Students who meet with me — well, I doubt they will ever pay off those loans. Some of them are making good faith efforts in the beginning, but as time goes on I think they will become disillusioned, and then get involved politically to get those loans discharged somehow.
The whole idea of student loans is kind of a fairy tale. You’re 19, you want to go to college to get a good job, satisfy your parents and hand with your friends, so naturally you are going to sign whatever it takes to do that. The whole idea of paying it back is kind of unreal to them.
“g, but as time goes on I think they will become disillusioned, and then get involved politically to get those loans discharged somehow.”
There is already an apparatus for this per the recovery act of 2009. Graduates need only pay 10% of income for 20 years (or 10 years if they work for government or public service ala teachers) and then all student debt is discharged.
One can argue this is a perverse incentive system that encourages MORE debt and HIGHER prices by providers of education since the end consumer knows in 10 or 20 years he/she can walk away from all the debt and lay it at the feet of the taxpayer.
More broadly speaking with the federal govt now controlling 90%+ of both the mortgage and student debt market the future ability to let the consumers of said debts off with get out of jail free cards during the next crisis is exponentially higher than in 2008. With the mortgage crisis the govt was handcuffed by the banking system – the only thing stopping a future democratic led white house from saying “all mortgages or student debt is now cut by a factor of 30% … since we are in a national crisis” is a right wing portion of the GOP.
Thanks for the response Cullen. Building on the baseball analogy, I just wonder if this one is going to go into extra innings.
Ha. Very well could.
Dead cat bounce.
if the balance sheet recession is over, will the fed stop the easing policy?
Interesting. I touched on that in a research note last night. I don’t think so. I think their communications have been pretty clear. They’re on hold for sure through 2013 at the minimum.
I like the part about Household Net Worth increasing by $1.1 trillion in the quarter. It makes the lousy $85 billion (or whatever) fiscal cuts look tiny.
Weird how private investment tends to make a bigger difference than govt spending.
Exactly. If I’d been focusing on NFA, I would have been short this market. Thankfully, I was not
The domestic private balance (S-I) peaked in nominal terms in Q3 2009 and the deficit has fallen 30% since then. Of course, private investment has risen 43% since then. So, you can net out private investment if your ideological view of the world makes you feel better about things. But, for those of us who are actually in the business of understanding the real world and rely on being able to accurately forecast future economic events, netting out private investment is like trying to understand how the human body works by first removing and throwing away the human head.
And the govt deficit is still pretty large by historical standards. The economy may be about to fire on all cylinders.
I strongly believe that income to debt is a proper indication of the where we are in the BSR, let along sustainability of income to debt levels.
EDIT: “IS NOT”
Agreed that comparing a stock to a flow is not the best indicator. I’d rather see income to interest expense or debt to assets.
Don’t worry. I’ve done my homework here. They tell the same story.
Doooode, you’re quick.
I really really want to tell you what you should be looking for so that you can ID a (subjectively) level of sustainability. All that I will say is that you are in the right direction, but taking those numbers superficially muddies any estimate of when the BSR ends (at least if you are talking about the “end” as equating to sustainable debt levels, rather than when the HH sector “appears” to be releveraging”).
So mysterious. Why not share your secrets with the group? I am happy to be corrected and admit faulty analysis if it leads to more accurate conclusions….
I notice your chart doesn’t shade in the period from mid-2012 until now. Why not?
The NBER didn’t acknowledge yet the recession has already started.
And the NBER is ALWAYS behind the curve.
Cullen,
Talking about general consumer debt to income is too vague, if not incorrect. What income is included? What about government transfers? Just imagine if government borrows another trillion per year (quite easy, by current standards) and trasfters the proceeds to “consumers”. Thus, we have quite goog debt to income ratio, which says nothing about real state of consumer.
To talk about the consumer debt in general is outright incorrect. All major categories should be analyzed separately. The current trend, when all categories except student loans are stagnating, does not say much about change in the deleveraging trend…
I would highly appreciate you posting some numbers to confirm the change in trend you are seeing.
See chart above. Includes household net worth. They’re the same basic overall story. This is what I’ve been using all along to predict the conclusion of the BSR….Which is why, in 2011, I projected these numbers out concluding that we’d likely be on the tail end of the BSR by about this time. We have some work to do, but I think 7th inning is a fair assessment.
Thank you. Do they have an explanation of the variables on FRED? PI can be anything. And still, to me it looks like we are just at the point where the previous crisis started. To re-start consumer debt driven sustainable expansion we would need to move to much lower levels. Otherwise, whatever mini debt buble started now (student???) would not grow a lot, would burst, and would kill recovery again. In the end we can get a series of such mini-bubles coupled with accelerating growht in govmnt debt….
To me it looks more like a revision to the mean of the trend-line that started in the 1960′s.
To me the charts indicate that everyone who had already loaded up on debt is deleveraging in aggregate and that those who hadn’t already loaded up (the young) are now loading up with student debt and so will be unable to load up in other categories like mortgage debt later.
Probably 20% of households have no borrowing capacity for a bigger home or extensions because of actual or near negative equity. Many others who have equity will have lower family incomes and insufficient repayment capacity to borrow long term for housing, limiting their ability to gear up. And some proportion will have poor credit because of foreclosure, short sale or 90+ day default.
I don’t think deleveraging is over for many households, and others can only borrow for say a car, but not for a new/bigger/better house.
Cullen, I know that you’re not always on the same page as Karl Denninger (understatement of the century), but how does this post reconcile with the following: http://market-ticker.org/akcs-www?post=218464 ?
When I first read the headline, my knee-jerk reaction (given that I’m a bit closer to the “middle” of middle-class than any Wall Street talking head) was to assign the debt expansion to increasing reliance on credit cards in the face of the expiration of the payroll tax cut as well as increased student debt. Karl’s analysis seems to confirm that hunch (or at least lend substantial support to it). I would love to hear your thoughts.
Thanks,
Rob T
I thought the sequestration was going to unleash hell on the economy………..
1. These are numbers of the 4th quarter of 2012.
2. These figures confirm the weak economic numbers. In spite of rising debt levels (which is in general good for the economy) US economic growth was a measily 0,1%. Guess what happens when the amount of debt stops growing (again). Economic contraction, anyone ?
Correction: the US economy contracted by 0.1% in the 4th quarter of 2012.
cullen — you have been prescient in calling the “balance sheet recession” and masterful in identifying its corresponding investment implications (subdued growth, no hyperinflation etc). So naturally, if you are calling a change (ie 7th inning) its raising (my) eyebrows!
By the time this ball game and we will enter a different economic period — what thoughts can you share as to how it will look like (2-5 years out) ? How will the balance sheet recession end and what will be its next incarnation?
Will we enter a higher inflation era? Will we have slightly improved growth but stay in the goldilocks economic sphere? Do you see these imbalances settling up the next crisis? Curious….! thanks, a
Check this out. D/I in hitorical terms.
http://www.newyorkfed.org/research/current_issues/ci18-8.pdf
It indeed appears that a deleveraging is occurring.
But in historical terms we are still way far north of an index of, say, 0.70 (mid-90′s), with a `12 year end index of ~0.95?
With debt on the rise through the 1st month of `13 and w/ the news indicating that the “I” part of D/I was heading south, I am having difficulty calling this ‘good’ news.
Who knows? Maybe it is!
Maybe the avg consumer has a much bigger apetite for debt than me. D/I still looks way to high (to me).
The real deleveraging story, from Z1
http://www.nowandfutures.com/download/d4/deleveraging_facts(fed).jpg