THE PAINFUL PROCESS OF DELEVERAGING

The San Francisco Fed is out with an excellent piece on the long-term complexities of massive debt unwinds.  This is an excellent summary of the crisis and one of the pillars of my longer-term bearish perspective.

The primary cause of the issues we confront is a massive accumulation of debt on just about every level of the U.S. economy.  From 1960-1980 the ratio of personal income to debt rose to 65%.  Over the next two decades that ratio increased to 133%!   Household debt remains extraordinarily high today.

hsholddebt

Obviously, this is an unsustainable trend.  Household wealth can’t lag debt levels forever.  Clearly, much of this surge in debt was attributed to the mortgage and securitization markets.  As housing began to buckle the ripple effect through the economy & the consumer was crippling.

Unfortunately, problems this large don’t end in a month or a year.  As you can see below, Japan provides an excellent model for what we can expect from the deleveraging process moving ahead.   As the FRBSF states, this ratio needs to come back to equilibrium which is still currently far away.

lvrgrat

Consuming this debt isn’t going to be a quick meal at the McDonald’s drive thru as we might see during a normal recession.  Rather, absorbing all of this debt will be more like a snake that eats a deer.  Expect a long drawn out process that could last much longer than expected and you can be certain that the economy will remain vulnerable throughout this process.

Of course, all of this creates opportunity.  Don’t mistake my outlook as permabearish.  Despite having a rather bearish longer-term perspective, there will certainly be bull markets inbetween and opportunities abound.   Finding those opportunities, however, will only become more and more challenging as the economy frustrates investors with its tepid recovery.

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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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