The Balance Sheet Recession is Over

I am glad (and sad) to say that the Balance Sheet Recession in the USA appears to be over.  Yesterday’s Z.1 report from the Fed confirmed that households have indeed begun releveraging.  Household debt showed its first year over year gains (on a quarterly basis) in Q3 since the crisis began.  The end of the BSR arrived just about on time.  Several years ago I predicted that the Balance Sheet Recession would likely end sometime in 2013 or so.

This is a good sign.  But we’re by no means back to levels where we were.  On the other hand, growth is growth.  The economy rarely grows without private sector debt accumulation so this is a sign that balance sheets are normalizing.  It’s also a sign that the tapering can begin without worry of imploding the markets.  The private sector is really starting to run with the baton here so we shouldn’t be terrified of the government stepping back some of its extraordinary measures here.



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Cullen Roche

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. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. Total private sector debt is still quite high – and while low interest rates mean debt service ratios are at lows, that obviously changes if rates go up. So can the private sector really re-lever much?

  2. Thanks for the updates and all your work over the years Cullen. I can count, on one hand, how many people have accurately forecast this economic climate and actually predicted many of the correct outcomes. You’re one of the few.

  3. I don’t understand what private sector debt accumulation has to do with how the markets react to tapering.

  4. how much of the rise in debt accumulation auto’s and student loans? Isn’t everything else still going down?

  5. You are probably right, but could it not be the case that things have gotten worse so people borrow to manage daily expences. This will of course not be sustainable, and if it is the case people should start to de-levereage almost imediately.

  6. Cullen is a rare bird. He understands the monetary system as well as financial markets.

  7. That is only IF rates rise. Could be a very long time before we see rates normalize. That would allow people to leverage quite a bit.

  8. Cullen,

    I would appreciate if you expand on your comment. Does your call for BSR end mean returning to “historic” rate of private credit growth? Do you also expect the economy to grow as it grew during past private credit expansion periods? Or it will be current growth level, just supported by private credit from now on?

    Also, do you expect it to end? If yes, when? When the private debt levels would reach 2007 level?

    How cyclical economic slowdown can the new private credit expansion? Or, do not expect any cyclical slowdown any time soon?

    Thank you,

  9. Can you clarify your statement regarding growth and private sector debt?
    Isnt private sector leverage mostly just for consumption purposes? Isnt private sector debt growth just pulling consumption and economic growth from future periods?


  10. Yes, people are re-leveraging so they can make ends meet. This thing will roll over hard and fast. The balance sheet recession is just in the early stages

  11. “Mortgages, the largest component of household debt, increased by 0.7 percent in the third quarter of 2013. Mortgage balances shown on consumer credit reports stand at $7.90 trillion, up by $56 billion from the level in the second quarter. Balances on home equity lines of credit (HELOC) dropped by $5 billion (0.9 percent) and now stand at $535 billion. Household non-housing debt balances increased by 2.7 percent, with gains of $31 billion in auto loan balances, $33 billion in student loan balances and $4 billion in credit card balances. ”

  12. Cullen, you have made a lot of very accurate calls the past few years You have also explained very matter of factly the operational realities of how the monetary system works and this is a great tool to many of us. Thanks

    I guess we will have to wait and see if the BSR has been put behind us. I think that this latest statistic is an anomaly in a secular deleveraging cycle. Consumers, in general, will not return to debt accumulation as they have previously IMO.

    QE has greatly distorted financial markets. At this point I think the fed is damned if they do and damned if they don`t on taper. The distoritions have already been created and the markets were never allowed to find fair value after the financial crisis; just a laymans opinion.

  13. I agree with you John. I would be very interested to know what demographic of the U.S. is releveraging and for what ends. I am fortunate enough to be part of what remains of the middle class and I don`t know anybody, personally, who is willing to relever for auto purchases, credit cards, or student loans. There is a fundamental shift in consumer behaviour.

    I just don´t buy the notion of the BSR being over and the consumer coming back to kick the debt machine back into gear. It seems more logical, like you said John, that the recent increases in auto debt, student debt and credit card debt are being taken on by individuals in dire circumstances for day to day needs.

    In regards to housing, between ZIRP and the fed having bought up 1,5 trillion in MBS these past five years, I don`t know how anybody can get a handle of the fair value of real-estate and its relation to the end of the BSR. If housing prices fall then net worth of many families will drop and we will be even deeper into the BSR.

  14. The tailwind is that, at the same time, the same people (us) don’t want to reduce spending, or have serious cuts. Republicans capitulated and we will keep a high level of spending while only make token gesture of spending cut, thus preserving a very high level of deficit. Look at Ryan-Murray.

    This is the new normal. Imagine if we return to the same level of deficit before 2007.

  15. So are we at a point where releveraging is good reguardless of what the money is spent on, since households were “underleveraged”, if that’s a thing? What’s an appropriate amount of household leverage?

    Is there a collateral part of that chart. People increased their debt amount, but is it helping net worth?

  16. Indignado,

    You would be right in your comment about housing except for your (and my) inability to see that finally a “free lunch” has been discovered in financial markets. Through mere “asset swaps”, which are easily explained using accounting identities the fed can prop up asset prices with no negative impact. Hence a free lunch. I stubbornly keep thinking there isn’t a free lunch but Cullen has proven (so far) that indeed we can do this as long as we remain “productive”.

    As a result, the private sector’s balance sheet improves as the Fed’s deteriorates. But in this new world, the Fed’s Balance Sheet can never deteriorate enough. It still sounds too easy and too good to be true.

    I still think growing inequality is the wild card that one day will come back to haunt us and the fed’s policies are the biggest catalyst in this travesty. There will be a free lunch until the 90% realizes that the free lunch was not only not free but the most expensive meal ever.

  17. Rates will go up eventually – it could be 1, 5, 10 or 20 years – and IMHO the longer it takes, the higher private sector debt is likely to be. So it’s all can kicking. I guess I don’t understand how the trend can continue without a substantial re-set in private sector debt?

  18. Yes, as individuals we must either de-lever, or be certain that our leverage will increase our own wealth. Of course we need others to be dumb (the economy in aggregate) while we take care of ourselves.

    We got into this mess by ill advised speculation and living beyond our means. Could that happen again? From here?

    I personally see one of 3 scenarios in our future – 1) another bubble, which will obviously end badly but is at least a temporary strong economy, 2) continued muddle through – where leverage stays roughly flat and so do interest rates, and 3) a deflation via deleveraging likely caused by a spike in interest rates, or dramatic cuts to the deficit/debt, or some combination of both (which is what we have now on a minor scale).

    For now it is muddle through…. and this could last a LONG time…. but eventually that’s going to change unless I’m missing something about how private sector debt really can go up in a healthy and sustainable way from here. Or I suppose if there are technological booms – like shale, and breakthroughs in healthcare – imagine advancements where you spit into a dish in a booth in the mall and it tells you if you have any reason to go to the doctor, and $50 hand held MRI scans for injuries, etc – bringing HC costs way down and creating a boom in those products as well as re-allocated personal income to more productive areas of the economy. But, these things are a long way off – hence my 1, 2 and 3 options.

  19. Inequality is Congress’ fault. I suppose the Fed is an enabler because they didn’t let the economy collapse as far as it would have in 2009 without their intervention. But just because your house isn’t engulfed in flames isn’t an excuse to do the right things.

    Nothing keeping Congress from raising taxes on unproductive speculation, and unproductive transfers of wealth via estates, and then using that money on education and infrastructure. This so-called “socialism” is how we got the middle class in the first place. 40 years of doing away with that, has, surprise, surprise, led to inequality and a lame economy.

    The Fed can do nothing about any of this. They enabled it by lowering interest rates the entire time allowing debt to fuel growth and mask the problems that supply side economics and deregulation has given us, but again, Congress – and we the people – are at fault for the actual laws.

  20. I find it interesting how the market remains calm despite consensus of taper start in march 2014. Market was full on tantrum mode 4months prior to the last consensus taper prediction (market corrected in may 2013 with september taper expectation).

    Either the economy has attained near escape velocity. The private sector will carry the momentum forward.


    Market is failing to price it in. Market thinks the fed is going to “renege” again.

    I have a suspicion that fundamentals will “unexpectedly” deteriorate as the taper day approaches. It will be blamed on an unforeseen headwind materializing from stage left.

  21. Thanks. I am a firm believer in the idea that understanding the world we live in will actually lead to us making better decisions in navigating it! What a weird idea, huh? :-)

  22. Agree! They are both resposnsible, it is a vicious cycle. Hard to say who started it all but if you remember, the fed was instrumental in doing away with the many rules we had in the books to prevent the sort of things that happened as a result of de-regulation.

    Remember congress relied on “sage” advise from the committee to save the world (the Fed and many others) and did away with the little, but essential, protection we had to keep people in power (money class) from destroying the world throgh greed. We all know they nearly did.

  23. Recovery from a credit collapse is a process, not an event. So I don’t think we’re going back to the boom times any time soon. It’s gradual. Balance sheets aren’t totally healed yet. But we’re getting better.

  24. Yes, no one really knows what’s going to happen here. I certainly don’t claim to have all the answers, but I am a big believer in the idea that I can substantially increase my odds of being right about things by understanding how the monetary system works and understanding the operational realities of the things that make the system work. I am certainly not proclaiming that this sort of approach will lead to flawless forecasting, but I think it should generate better forecasting.

  25. Well said. Growth, even if very modest, is still growth. I’d say the private sector is beginning to jog (not run) with the baton. I’m sticking with my prediction that this will prove to be the longest “muddle through” in decades for the USA.

  26. You have laid down a framework in which to navigate this very complex financial landscape. I don´t agree with a number of your forecasts, but your track record speaks for itself these past few years. You definitely keep me questioning my personal economic “belief system”, and this itself has been of great value. Thanks.

  27. I second that! We have learned so much from you. This site is a must read. Even if some of the decidedly negative forecasts many of us on the site fear end up playing out, the truth is that even if we are right, you have proven most of us didn’t really understand the way the system works.

  28. Yes, we are getting better, yet still the scenarios can be quite different.

    Private credit expansion can, for example, show some life at levels significantly below historical for couple of years, and then crush again when next cyclical downturn, or a black swan arrives. Thus, it could be just a blip in the middle of a big BSR.

    Or it can be an accelerating process, getting back to 5%-10% historical level on sustainable basis, putting the real end to BSR and starting another secular credit expansion cycle.

    Which one is it, and why? I assume you have some ideas….

  29. Student loans have been going up at the same rate forever, so they don’t signal much of a change. Since it seems to be more difficult for recent grads to find work, and since student loan defaults are on the rise, I would think this is a net negative in the end anyways.

    If you look at the last “exapansion”, HELOC debt was increasing, and auto loan debt was decreasing. Since home values were also increasing, the folks felt awash with spendable cashola. The situation is now reversed, folks feel very insecure about their home values, and they are being forced to replace their most expensive depreciating asset (their cars), becuase their old cars are worn out and worthless. This actually is stressing folks out even more. They have a big nasty new car payment, and they feel fearful of their home values, can’t lever against their HELOC, and are afraid of losing their jobs.

    I’d say, this period of leveraging is not based in optimism, which would lead to increased general consumption. It’s based on distress to some extent. I would not use this as a guage to predict acceleration in the current “expansion”.

  30. Who said anything about a Free Lunch? Certainly not Cullen. Quite the opposite in fact. QE isn’t inflationary precisely because it isn’t a free lunch. The Fed isn’t giving away free money to anyone. It is not dropping cash from helicopters. It is simply purchasing assets on the open market.

  31. My favorite part about your predictions being right is that you proved how misguided M M T was in the process. Anyone who focused too much on the budget deficit this year got their teeth kicked in. Mosler looks like an idiot this year whining the whole year about the sequester. Morons.

  32. Steve Keen’s latest video discussed what he thought might happen with tapering, as well as unwinding, of QE. He also spoke a bit about the latest indications of re-leveraging.

    I’d be curious about the take of folks here on his most recent work and thoughts as shown in this video (ah, and he even pointed to an article within Bloomberg, which I noted Cullen was the author of… he didn’t discuss it specifically, but was mainly showing that the likes of Bloomberg were showing points of view that were out of what used to be the mainstream):

    “What might happen when Quantitative Easing is Eased”

  33. Whoops! No, he was pointing to the article about QE in Bloomberg through Cullen’s post on PragCap from the other day… (I just remembered seeing Cullen’s name and Bloomberg until I just reviewed the video and also just read Cullen’s recent post highlighting the article on Bloomberg, ;-).)

  34. It’s nice to think that Steve Keen may be reading Cullen Roche on PragCap, ;-).

  35. Ha. Yes, he cites the article here at Pragcap which was my response to a Bloomberg article. He calls the source “authoritative” even though Pragcap was technically the source. Not very authoritative if you ask me! :-)

    Some comments:

    1) I don’t like how he calls govt spending “money printing”. Govt spending is better described as “asset printing” b/c they’re just really printing the bond, not money.

    2) I like how he runs the counterfactual with a budget surplus. This is a point I often make about QE. QE only with fiscal policy only increases financial assets if it’s included with a budget deficit.

    3) QE removes high quality collateral (t-bonds) for shadow banks to use.

    4) I like his use of “asset swap”.

    5) I think he’s right that QE is helping banks.

    6) I think he’s right that it’s not the economic event so many have made it out to be.

  36. Thanks for that, Cullen.

    It helps to see some of you folks bounce things off of one another, to see where commonalities and differences lie, agreements/disagreements.

    He’s starting to incorporate more into his model, such as primary dealers and shadow banks, which I was wondering about – will he be able to model the “dealers,” which Perry Mehrling stresses as being such important components to modern economics, including the Fed taking on the role of “dealer of last resort,” the modern step beyond “lender of last resort.”

    Now, I don’t know enough yet to know if Keen is modelling them as accurately as Mehrling would call for (can he get the bid/ask spreads in there, for example? would it be helpful if he did? would it matter to do so?) but he’s continuing to develop the Minsky Project, for sure. And that’s really interesting to see.

    Mehrling talks of all actors within the monetary system (including individual households) as “banks,” in a way, or at least that they/we all can be included via the common language and relationships of “balance sheets”/”double entry accounting.” And if so, maybe Keen’s model will eventually be able to work with the various components that Mehrling would call for. (Someday, maybe I’ll “get” this stuff enough to know whether Keen’s model can truly handle those key components or not.)


  37. After prior QE/LSAP programs ended, stocks values fell and bond values rose. In the recent taper tantrum, stocks wobbled a bit but bonds were hammered. If the balance sheet recession is over and releveraging is underway, bonds are a bad bet. If releveraging is a mirage (student loans and subprime auto loans may not be an accurate reflection of consumer demand in the real economy) then the taper tantrum was a head fake as far as bonds are concerned. Debt markets are bigger than equity markets, and so there is a lot riding on the interpretation of the data cited by CR.

  38. Yeah, we get it. You’re smart and you have been right about a lot. No need to trot it out so often. I can’t wait until you’re hugely wrong about something so people rub it back in your face.

  39. According to a chart at Doug Short, student ebt is the largest US Gov’t financial asset.

    I understand student loans survive bankruptcy.

    This will be putting a cramp on banks’ credit analysis from 2 points:
    1. The existing debt levels of graduates when they come to do an Asset & Liability statement for the bank which will likely show negative net worth for many years.
    2. The fact that the future income of the graduate will continue to be charged to the student loan even after bankruptcy.

    Lending for houses in full recourse states will likely be affected by these factors, but less so in non-recourse states.