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Why It Could Take Years to Recover

Economist Hyman Minsky studied how debt overload leads to economic catastrophe. A few years after his death, another economist used Minsky's work to coin the phrase "Minsky moment," which is when an economy gorges on more debt than its cash flow can bear. Once you hit a Minsky moment, all hell breaks loose as everyone tries to delever at the same time.

Needless to say, we've had a Minsky moment. Maybe a few. The punch bowl of endless credit has been replaced with the smelling salts of reality, sparking one of the worst recessions since the Great Depression.                                      

Thanks for stating the obvious
When will it all end? I have no idea. No one really does. But we do know that it can't end until we have the opposite of a Minsky moment -- when our debt load becomes reasonable and sustainable again.

Unfortunately, this is a larger task than many assume. See, the explosion of consumer debt is not a phenomenon that began with the housing bubble in 2003. It's a trend that started decades ago. Have a look:


Household Debt/Disposable Income



















Sources: Federal Reserve, Bureau of Economic Analysis, author's calculations.

Ask yourself what's changed since the '70s and '80s that allows us to handle a debt load nearly twice the size. Some might say lower interest rates, but this is a debatable point: Interest rates could, and likely will, be just as high again someday as the Federal Reserve mops up all the cash injected over the past year. By any historical measure, our debt load is horrifyingly large and will need to come down. By a lot.

What's important is the impact reducing debt has on the economy, which is what's happening right now. Looking at the past several quarters, here's how much of a dent households have made on debt loads:


Household Debt/Disposable Income

Q1 2009


Q4 2008


Q3 2008


Q2 2008


Q1 2008


Quite pitiful, I'd say. In a year when consumers shut their wallets so severely that it drop-kicked the entire economy, household debt inched back merely a few percentage points.

With that in mind, think about what kind of retrenchment it'll take to get household debt from the current 128% of disposable income to the 35-year average of 88%, or something just reasonably close. Now I think you'll see why a sustainable economic rebound could be years, not months, away.

What now?
To get back down to a few randomly chosen debt/disposable income levels, here's how much money has to be pulled from consumers' pockets:

To Get Debt/Disposable Income Down To:

Would Divert This Much From Consumer Spending:


$1.4 trillion


$3 trillion


$4.6 trillion


$6.8 trillion

Anyone got a few trillion sitting around? Me neither. The money obviously has to come from future savings.

Thankfully, people are saving again in a big way. The personal savings rate has shot up from slightly negative in 2005 to about 4% today.

But even a 4% savings rate equates to just $476 billion per year -- a fraction of what we need to get household debt down to safer levels. If we took every penny we're saving today and put it toward paying off debt, it would take more than six years to get household debt back to 100% of disposable income -- about where it was in 2001. Using the same savings rate, it would take nearly 10 years to reach the 35-year average of 88%. Giddyup!

Who will this long-term debt deleveraging affect the most? A few industries in particular:

  • High-end consumer discretionary companies, such as Coach (NYSE: COH  ) and Best Buy (NYSE: BBY  ) . More debt servicing means less conspicuous consumption.
  • Banks that relied on debt growth. Citigroup (NYSE: C  ) , Bank of America (NYSE: BAC  ) and American Express (NYSE: AXP  ) made gobs of money financing anything and everything households wanted; what happens when they face the first long-term credit contraction in a generation? Shrinking balance sheets will be an unwelcome surprise, especially as they slog through losses on existing assets.
  • Real estate companies like Pulte Homes (NYSE: PHM  ) and D.R. Horton (NYSE: DHI  ) . The majority of household debt is comprised of mortgages. Deleveraging naturally reduces demand, which could compress prices for years to come.

Moving right along
These shifts are necessary and will eventually lead to a more stable economy. But that doesn't mean they come without pain. The idea that recovery is right around the corner relies on the assumption that consumers will start spending like they did in previous years. But when the average household is choking on a generation's worth of debt, that can't happen right away.

Problems that take decades to create aren't solved in a matter of months. It really is that simple.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. American Express is a Motley Fool Inside Value pick. The Fool owns shares of American Express and has a disclosure policy.



Read/Post Comments (16) | Recommend This Article (73)

Comments from our Foolish Readers

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  • Report this Comment On June 24, 2009, at 2:12 PM, jmt587 wrote:

    To play devil's advocate for a minute (not that I disagree with your overall point that this will be a tough slog, and debt needs to come down), to me, the dent made does not seem insignificant. If we've knocked our savings rate up from 0% to 4%, and also knocked our debt as a % of disposable income down more than 5% in a year, and over 2% in a single quarter, at the same time, and also in a time when I'd wager it's likely that disposable income has decreased, it seems like we can really crank through this problem more quickly than I would have guessed, before reading those numbers.

    Anyhow, thanks for the numbers to look at and think about, they've cheered me some, even if you take the opposite view of them. It would be interesting to know how much of that reduction in debt is debt paid down vs. debt written off (foreclosures, short sales, cc charge-offs, auto reposessions, etc.).

  • Report this Comment On June 24, 2009, at 2:37 PM, PhillyDan wrote:

    Very informative article. Some of the blogs written here are all doom and gloom. Your article is pragmatic and deals in reality. I agree with you that the economic rebound will take some time because of the debt burden that we as consumers took on over the last several years. A lot of that debt was built on the "false reality" of house values and a continuing rise in those values. Consumers were willing to take on more debt because they assumed the rising value of their homes would offset that additional debt burden. I also think that lower interest rates contributed to this increase in debt burden.

    I think most consumers have come to their senses and hence that is one reason for the increase in the savings rate. I think this new attitude is positive for the future since we will have reasonable economic growth and not growth based on some bubble (e.g., Dot-Com, Housing, etc.) phenomenon. I think the economy is in a stabilization mode and we will now start to see a recovery but it will be as you indicated a slow and longer recovery. Again, I think this is more positive than a rapid recovery since that might force both companies and consumers into the old bad habits again.

    I for one have just reduced my debt by $55K cutting it by 60%. I plan to pay off the remaining debt within 12-15 months. I think what I am doing is happening across America and therefore, I think we will reduce the average debt burden a bit quicker than you have forecast.

  • Report this Comment On June 24, 2009, at 5:10 PM, Guthree wrote:

    I enjoyed the article, but you might want to point out somewhere that household debt does not include home mortgage debt. Right? I wasn't certain, so I kept reading the article with uncertainty...

    Is it a case of debt going up or disposable income going down? Maybe it doesn't matter.

    I wonder if people who bought their McMansions a few years back, brushing over issues like higher insurance, property taxes, and utility bills, will come to see those $300-$400/month "throwaway dollars" mean a lot more to them now, and in the future, than they did in 2005 (or 1999)?

  • Report this Comment On June 24, 2009, at 5:14 PM, cmfhousel wrote:


    Household debt does include mortgage debt. The article states "The majority of household debt is comprised of mortgages."



  • Report this Comment On June 24, 2009, at 5:15 PM, Guthree wrote:

    Sorry, but a couple more points...

    As people pay down debt, the money supply automatically decreases, just as borrowing increases it.

    Also, I strongly suspect people will never return to old habits in their lifetimes. I think of my own case. I experimented with cutting my own hair a while back. It worked so well, I bought a full (cheap) clipper kit. I used to spend $20 to get my hair cut every couple of months. I can't see myself doing that again. Probably others like me. And maybe women stopped getting their nails done and find they don't miss it, and in fact are happy to have the extra time gained by NOT getting them done. There are thousands of similar examples I'm sure.

    Overall, I think this is probably good for the nation and good for us as individuals. Rather than buying expensive coffee table books no one ever reads, maybe people will buy cheap paperback classics and spend the time to read them.

  • Report this Comment On June 24, 2009, at 5:16 PM, Guthree wrote:

    Thanks, Morgan. I missed that.

  • Report this Comment On June 24, 2009, at 5:18 PM, TicoHombre wrote:

    I'd like to build a little on what jmt587 said.

    Wouldn't the delevering actually pick up momentum as each year passes?

    The reason is that the more debt paid off, the more resources available to throw at the remaining debt. Basically like snowballing credit card debt. After the first card is paid off, you know have those freed up funds to throw at the second card and so forth. I can see where the pay down of debt could take on much greater velocity with each passing year.

    Does that make sense given this scenario?


  • Report this Comment On June 24, 2009, at 6:40 PM, jackcrow wrote:

    I disagree on Coach. Luxury shops that cater to the well monied have a customer base that rarely is forced to cut back for an extended period. A moment of, OH NO, then they reach into their back pocket and find a couple 100k and return to the store.

    One grossly overlooked issue in all of this has been the deeply descending interest rate that corresponds to the savings rate. There has been no reward for the saver. Either pile into the stock market or get diddly.

    Cheap money is a two way street. Cheap to borrow, pointless to lend

  • Report this Comment On June 24, 2009, at 7:29 PM, xetn wrote:

    If you want to see where the real debt problem lies, check this:

    As for Guthree's comment about reducing the money supply, how is that a problem, since the FED has added several trillion to the economy since the crisis began? It is actually a good thing. Besides, the number of dollars in the economy is not critical, as a matter of fact almost any number of dollars is enough. Since money is only a medium of exchange, its price (purchasing value) changes with the number of dollars. For a simple example, if there were only 1000 $1 dollar bills in circulation and equaled $1000. what would 2000 bills equal? Still $1000. because the value (purchasing power) of each dollar would have dropped by 50%. Likewise, if the number of dollar bills had dropped to 500 what would the value of each dollar be? Although this is very simplified, it never-the-less illustrates the point that one of the tenants of the FED is to provide a stable dollar and that is impossible. There is no such thing as a stable dollar, even if we were on a strict gold standard, new gold added to the market would change the value of existing gold.

  • Report this Comment On June 24, 2009, at 10:34 PM, rritterson wrote:

    The article's point stands, but the statistics leave something to be desired.

    It's inappropriate to calculate an average on a steadily increasing number and then use that average as a historical norm, as this article does for debt/income ratios.

    It's similar to taking the average point value of the Dow since 1926 and then claiming the market is overvalued until it returns to that number.

    Also, dramatically increasing the money supply makes it much easier to destroy debt, as there is that much more money out there to do it with. An added bonus is inflation, which has the net effect of making debt balances cheaper and easier to pay.

  • Report this Comment On June 24, 2009, at 11:45 PM, booyahh wrote:

    "As for Guthree's comment about reducing the money supply, how is that a problem"

    Mulitplier effect. When money is loaned out it flows through the system, increasing value of multiple assets and benefiting numerous people. When money is paid back, society gets the muliplier effect in reverse: the velocity of money flowing through the system slows down, and assets fall in value, sometimes deflating for years and years as the deleveraging continues.

  • Report this Comment On June 25, 2009, at 3:57 AM, TangoToo wrote:

    Yes, isn't that the M2? Can't remember all my National Income Analysis math, but the money supply that moves the economy is the product of all those loans which banks (and now other financials) make, which can be quickly manipulated by feds raising or lowering the reserves lenders keep.

    All that does not make it easy for householders to pay back all the easy money they spent on widgets long since thrown away, or in the case of an expensive house, are no longer marketable at the desired price.

    But paying back loans does not mean stopping all spending, and as the interest load drops, spending goes on up. So the crystal ball stays cloudy, doesn't it. The real winners will be known because they will still be standing when we look back at them.

  • Report this Comment On June 25, 2009, at 10:05 AM, cjb44 wrote:

    I agree with Guthree on spending habits. In Maryland they raised the sales tax and now I shop online when possible. No sales tax, free shipping and I don't waste gas going out. Even if the sales tax is dropped to where it used to be, why would I spend extra money to the government when there is a tax free option?

  • Report this Comment On June 25, 2009, at 11:42 AM, brigidl wrote:

    From 2003 to 2008 average debt was typically 123% yet for 4 of that 5 years we carried on on what was considered a booming economy and stock market to match. Then the penny dropped and the consensus that we as a world were over-borrowed. The point is this, our economy's health are dependent not on our borrowing to disposable income ratio, but on the perception of the state of affairs. I maintain that when jobs are percieved to be secure and when debt is paid off resulting in more money is one wallet the feel good factor will return,and spending and the economy will pick up. You dont need to return to a specific %age debt figure to have a recovery

  • Report this Comment On June 29, 2009, at 10:45 AM, TimothyVR wrote:

    You provide a chart indicating the decline in consumer spending necessary to reach various level of debt, but you don't provide estimates for growth in income or how many years it would take to reach those levels.

  • Report this Comment On July 01, 2009, at 2:36 PM, plange01 wrote:

    it will take years to recover simply because we are no where near the bottom yet.the US has been in a depresssion for just over 6 months! it will be years before it ends....

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