Monday, March 2, 2009

Consumer debt not a big problem


In response to this request: "I'm wondering why you never post or review the long term data on net consumer debt. Even when removing record low home equity, comsumers have more debt as a percent of disposable income than ever before. Isn't this at the root of the crisis we face?"

This chart is the answer, and I think I've posted it before. The data for this chart only go through September '08, unfortunately, but I doubt things changed significantly in subsequent months. The important thing here is that the chart measures payments on debt and other financial obligations as a percent of disposable income. If you compared total net debt to disposable income you would get much larger ratios, but that is not a valid comparison. Consider a family making $100,000 per year. If they took on $50,000 of debt with a 20% interest rate (e.g., credit card debt) that would be a lot more burdensome than $50,000 of mortgage debt with a 6% interest rate and 30 years to pay. You have to compare flows (debt payments) to flows (income). You can't compare the stock of debt to a flow of income—that's apples and oranges.

Back to the chart, we see that debt and financial obligations are only slightly more burdensome today than they were 20 years ago, and roughly the same today as they were just prior to the 2001 recession. I fail to see where or how this chart displays any big warning signs of impending doom, or how it could be at the root of our problems today.

19 comments:

Gene Prescott said...

Scott,

Thanks for responding to Mark's question and posting the chart. Visually the change for Total Financial Obligations from 16% in 1980 to 19% in 2008 'looks' like a lot of change. I believe Tufte would display this data on a chart that starts at 0% rather than 7%. On such a chart the 'visual' perception would convey same message the left side numbers do.

Thanks again for all you do.

Mark Gerber said...

Scott,
Thanks for posting this chart!

Even though I mentioned debt as a percent of disposable income, and you presented just that, I'm now wondering if it would be more meaningful to look at consumer debt as a percent of GDP? Charts I have seen of this metric show that this ratio accelerated around 2001, rising from around 65% of GDP in 2001 to about 100% today. From 1965 to 1985 this ratio was failry steady at around 45%, and from 1985 to 2001 it rose fairly linearly to around 65%. To me, this appears to confirm that excessive consumer (household) debt is a problem today, and will make recovery from this crisis more difficult.

I think you make a good point that it might make more sense to look at debt service rather than principal to neutralize interest effects. At the risk of taxing your generosity for this blog, could you post that chart and your analysis?

Thanks Scott,
Mark

Bernard said...

I was thinking along the same lines as Gene.

Include delinquency rates, broken down by debt type, in order to provide a better picture of the relative performance of this debt over time. Mere percentages do not tell us whether there is underlying stress in the system.

It is impossible to know if consumers are reaching the tipping point with the chart provided...


B

Scott Grannis said...

To address Gene's point, I have replaced the chart with one that has a y-axis beginning at zero. To me it tells the same story: debt service burdens have increased very slightly over the past 28 years. A rise from 11% to 14% or from 16% to 19% is just not a big deal and I don't see how it can obscure anything.

The big deal, of course, is the decline in housing prices and the wipeout of subprime debt that it triggered. That's all you need to know about the problems with consumer debt in my view.

Bernard said...

Scott,

What do you make of this? If consumer debt isn't an issue, it seems credit card companies are tryng to make it one...

http://www.bloomberg.com/apps/news?pid=20601087&sid=adCwmmkzFI3U&refer=home

Scott Grannis said...

I think it says more about American Express regretting its decision to get into the business of consumer lending than it does to consumers being generally overextended.

Nevertheless, it is true that everyone is trying to deleverage these days, and that is part of the problem: everyone rushing for the exit at the same time.

Gene Prescott said...

Of course I can't speak for Tufte, but if I understand his premise for visual display of information correctly, I think he would be pleased with the revised chart. His point is that the visual should convey the message correctly whether one reads the numbers on the left axis or not.

Thanks.

B_Rad said...

I think this is the chart you were looking for Mark...http://media.npr.org/blogs/globalpoolofmoney/images/2009/02/household.jpg

Slingblade9119 said...

Scott

I think this is misleading becasue it reflects PAYMENTS. If most people are only paying the minimum monthly payment of 2% or 3% of then this chart would reflect a rosey picture. I would like to see (and have been unable to find) a chart the shows historical consumer debt balance as a % of Assets - THIS would be a better reflection (i think) of the consumer credit issue.

Scott Grannis said...

Slingblade: Since, according to the Fed, consumer credit (the only sort that would give borrowers the option of making only a minimal monthly payment) comprises less than 20% of total household debt, your theory is highly unlikely to explain why debt burdens are significantly understated. Even if a substantial fraction of those with credit card debt paid only the minimum monthly charge, it would not cause this measure of debt service burdens to increase by much.

Scott Grannis said...

It occurs to me I should note that this chart of household debt service burdens is an aggregate of all households. This does not preclude the possibility that some fraction of households (10%?) took on an unduly large debt service burden in previous years, while others reduced their burdens. So far, less than 10% of outstanding mortgage debt has defaulted, and that's been enough apparently to precipitate this crisis.

Steve said...

Well, I'm convinced. I'm going to buy a big slug of COF today in honor of your post ...

You have to be kidding me. You actually got paid for producing this pablum durng your career?

Are you trying to say that the level of debt means nothing?

Debt servicing as a % of income has risen over the past decades at the same time that interest rates have moved from historic highs to historic lows. That should be incredibly frightening to anybody who is not concerned with providing Larry Kudlow bullish meat for his grinder.

Its not all about cash flow. If we've learned anything in the last 18 months, its that BALANCE SHEETS MATTER! ... the consumer balance sheet is wrecked. Asset values have fallen (and continue to fall) while debt remains. Credit gets turned off, which prevents the piling of even more debt on this insanely structured entity. That leaves two choices: 1. bankruptcy, which will remove enough debt to make the balance sheet solvent. 2. increased saving that can be used to pay down the debt over a long period of time.

Both of these will lead to improvement in the economy over the long term, but are not quick fixes.

mrdon said...

Having seen this chart posted before, I went to the original source, the Fed Flow of Funds Report to see what was behind it. I won't speculate as to how much debt is "too much debt", but the underlying data shows that consumers borrowed a net 5% more per year than they earned starting around 2000. I don't know how much is too much, but I do understand that you cannot spend 5% more than you earn each year indefinitely. The old argument was that the value of our assets was rising fast enough to account for our increases in borrowing -- if only our "assets" hadn't turned out to be tulips.

Another eye-opener is a chart Morgan Stanley recently published depicting total U.S. debt as a percentage of GDP. It is now approaching 350% and has increased at a rate of over 9% per year since 2000. Again, it is hard to see how you can indefinitely increase total borrowing at a rate of 9% per year when the real GDP is only increasing at something less than 3%. Ah, but that is the beauty of leverage -- isn't it?

Houston, we have a problem.

Scott Grannis said...

Points noted, but I would maintain that the typical consumer did not take on an excessive debt burden. A fraction most likely did, while another fraction paid down debt. This whole crisis was precipitated by the actions of a fraction of all households on the margin. That's not to say the crisis doesn't exist, but it does imply that not everyone's balance sheet is wrecked, and that therefore there is reason to think we are not trapped in a downward death spiral as the pessimists are trying to argue.

mrdon said...

Scott,
This may have been precipitated by a fraction of households on the margin who took on excessive debt, but it has destroyed the balance sheets for many more of us who were responsible. I have no debt, and I used to have a lot more savings than I do now. Nothing will bring me out of my "frugality shell", because my economic circumstance well keep me here for the foreseeable future (I am retired). The era of having a cowboy president suggest that we ought to just "spend" our way to prosperity is over and done.

And if there is anybody so wild-eyed as to believe that past public spending has been even remotely responsible, our new "non-cowboy" president is fixin' to spend us into a world of hurt. It isn't going to matter whether consumers regain their appetite to borrow if the money is going to be "borrowed up" by the public sector. There has to be an ultimate limit to how high total borrowing can go before it crowds out investment in the "factors of production" and slows or stops real growth. Even before "the One" gets his grip on spending and borrowing, the U.S. is at a historic high water mark with total public and private borrowing approaching 350% of the GDP. You may be confident that consumer borrowing is no problem. I can't share your optimism.

I believe that when the so-called problems related to "lack of money to lend" is resolved we will discover that it simply masked a decline in "people qualified to borrow".

Scott Grannis said...

mrdon: my portfolio has suffered severe damage as well. I think I expressed myself badly on the original post. There were obviously a lot of irresponsible people who borrowed too much. I know some personally. But in aggregate I don't think the American people borrowed too much. Sadly, the majority of people were responsible yet they are the ones now paying the price. The real sources of this mess are many, and the government and our politicians share a lot of the blame. And the Fed. The list is long.

I am reminded of the Latin American debt crisis of the early 1980s. The apparent source of the problem was governments who borrowed way too much and then got wiped out when commodity prices fell. But the real problem started with inflationary monetary policy in the 1970s which caused everyone to bet massively on commodity prices rising forever. When that bet failed, the collapse was foreordained.

Borrowers may have borrowed too much, but lenders also were too willing to lend and not suspicious enough of how risky everything had become. Freddie and Fannie were trillion dollar borrowers and lenders, however, and they were the 800 pound gorilla in the living room.

mstrwils said...

I'm curious on thoughts regarding a consumer liquidity trap. Consumers are capable of servicing their debt is what I take from the chart above. However, their ability to aquire new debt may be hindered by two variables. First, incremental debt has become more expensive via higher infered risk and therefore wider credit spreads. This is limiting demand for new credit (debt) and leading to stagnate consumer spending. This has led to economic fallout dependent on growth in consumer spending and job losses which inturn leads to reduced income. Income is the divisor in the chart above and as income falls it levers up the existing debt. This is a vicious cycle. So I was thinkink about how we can drive demand for new debt and therefore spending. First, you need to fix the liquidity trap consumer debt is currently in where there is no supply pushing credit spreads up and forcing demand out as well. I believe the TALF program will help this. Second, the more unfortunate event is asset/goods prices need to fall where the consumer is paying the same amount of interest on that asset/good as before. The paradigm here is that we can't continue to reduce real interest rates forever.

mstrwils said...

The last portion of my comment got cutoff.

I wanted to note that we need real income growth to maintain growth in debt. This ties the two arguments together. Financial innovation has allowed real interest rates to decline allowing for total debt to GDP ratios to increase. This is fine but it may have been over done as eventually that ability to leverage income through lower real interest rates needs to level out (real interest rates can't go to zero in the longrun). This means that income will need to begin rising close to the pace of debt levels as the ability of financial innovation to reduce interest rates slows (financial deepening matures). This should level of the % of financing cost as a portion of disposable income. My thoughts are how much further can financial innovation go or will it retract with higher regulation? This has enormous repercussions.

Scott Grannis said...

mstrwils: I think you focus too much on the demand side of the economy. As a supply-sider, I believe that supply creates its own demand. We don't need to try to get consumers to borrow more and spend more, we need to lower the barriers for those with money to put at risk. We need more investment, more risk-taking. That is what creates jobs and more demand.