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What the Most Important Statistic Says About Our Recovery

In medicine, doctors try to address underlying causes, not just symptoms. The term for this is etiology. As surgeon Atul Gawande explains in his book Complications: "As a rule, fixing what's physically wrong ... is precisely the way to relieve suffering."

We'd be better off if more economists thought this way. Instead, there's a terrible tendency to focus on symptoms -- unemployment, GDP, manufacturing -- while ignoring a root cause of these symptoms: consumers buried in too much debt.

That said, I think this chart tells a powerful story:

You can sum this chart up in two words: Minsky Moment. It's an unpleasant event named after economist Hyman Minsky in which debt payments reach impractical levels, people run into cash-flow problems, and then all hell breaks loose as the Ponzi scheme unwinds. The fireworks that follow are just a symptom of the underlying cause.

Nevertheless, things are clearly getting better now. The chart is headed in the right direction: down. That's great! But it's not as impressive as you might think, and the mechanics of how we got here may surprise you.

Moving on down
First, has debt come down? It depends what kind of debt we're talking about.

Let's start with consumer debt -- things like credit cards and auto loans. Plenty of attention has been paid to headlines like "Consumers are paying off their credit cards." And they sort of are, but it's not the whole story.

As Reuters columnist Felix Salmon points out, last year's $93 billion drop in outstanding credit card debt was comprised of two parts: $83 billion of bank charge-offs and less than $10 billion of consumers actually paying down their balances. Moreover, the only period debt was paid down on a net basis was during the first three months of the year. From April to December 2009, consumers actually added $37 billion to credit card balances.

So while credit card debt is falling, it's the sacrifice of banks -- not consumers -- that should be thanked. Consumers are still eager to pile on debt as long as banks are eager to eat the losses. And the performance of card divisions at Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , and JPMorgan Chase (NYSE: JPM  ) prove that they are.

But regardless of reason, consumer debt payments as a percentage of disposable income have actually fallen back to average territory. Since 1980, the median level is 5.7%. In the first quarter of this year, it was 5.4%, down from 6.7% in 2005. (That statistic only applies to homeowners, which is how the Fed releases its data. The similar statistic for non-homeowners includes rental payments and shows almost no discernible increase during the boom years. Renters, it turns out, never got carried away with debt.) This fall in consumer debt levels is encouraging -- it shows that we're getting back to an order of sanity. Embrace it.

Just don't read too much into it
The consumer debt bubble was, however, fairly mild compared with the mortgage bubble. One reason for this is that consumers used low-interest home equity loans to finance purchases that otherwise would have been charged on credit cards. You could even use a home equity loan to pay off your credit card altogether. Remember the infamous "housing ATM"? Mortgages essentially replaced some consumer loans.

So it might not surprise you to hear that mortgage payments as a percentage of disposable income is still a simmering bubble.

Historically, the average mortgage payment makes up 9.5% of disposable income. It rose as high as 11.3% in 2007, and has since fallen to 10.5% -- a nice drop, but still firmly above average.

The drop might also be seen as meager considering mortgage interest rates have collapsed to the lowest level on record. This should push mortgage payments through the floor for both new buyers and existing owners who refinance. Even so, the average mortgage payment is still too high.

What this shows, I believe, is that consumers not utilizing lower interest rates to save money, but to continue to buy more home than they can afford. All of this is just to say that housing prices still have a ways to fall. I don't see many practical ways around that.

The third variable in this chart is income.                             

With the employment situation a complete trainwreck, it's easy to assume incomes have been bludgeoned. But that's not entirely the case. Since 2005, average nominal hourly wages have jumped from $16 to $19. Even with millions of jobs lost and the savings rate surging, real (inflation-adjusted) consumer spending is back to where it was in mid-2007, much of which can be attributed to income gains.

The reason it feels like consumer spending has disintegrated is not because we're spending less, but because of how our spending has changed. If you're a gardener in Las Vegas, business has practically vanished. But if you're Wal-Mart (NYSE: WMT  ) or Dollar Tree (Nasdaq: DLTR  ) , in the business of saving people money, sales have never been better. People are still spending money, just in different places.

The ugly road ahead
So, consumer debt levels look OK, housing debt levels are still too high, and incomes are generally rising. The good news is that we're getting back to normal; the bad news is that we're not quite there yet. Housing prices still need to fall considerably to bring us back to a happy, stable equilibrium.

That will be painful, and politicians and policymakers will fight to the death to prevent it. But remember what Dr. Gawande says: "fixing what's physically wrong is precisely the way to relieve suffering." Etiology is as important in economics as it is in medicine.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't owns shares in any of the companies mentioned in this article. Wal-Mart Stores is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (26)

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  • Report this Comment On August 07, 2010, at 3:21 AM, jadenjones28 wrote:

    Well, we might see the total outstanding credit card debt is decreasing, but we hope that the new Credit Card Act as well as FTC's regulations on "unscrupulous" debt settlement firms would eventually bring down total credit card debt as low as possible. Keep you fingers crossed:)

    For more credit card debt relief tips ~ visit

  • Report this Comment On August 07, 2010, at 8:07 PM, JBKirtley wrote:

    Agreed, consumer debt (including yours truly's) is too high. I have a plan to be paid off in December. But how many unemployed are still walking down debt road by using their credit cards to "help make ends meet" while they search for work. Benjamin Franklin contended that man will do the laziest thing unless he is allowed to become uncomfortable in his poverty and I agree. Had congress had the guts to block continued UE benefits, we might be beginning to notice an uptick in temporary hires, which for me is a reasonably good indicator that an economic recovery is beginning. So my view in a nutshell is debt will continue to rise as long as the government is paying workers to stay home.

  • Report this Comment On August 08, 2010, at 9:53 AM, PEStudent wrote:

    I like the claim that debt reduction is due to "the sacrifice of banks"! You mean that after raising rates into the 24-33% range for people with plenty of assets and you always make payments because they have sudden loss of income etc, it's a sacrifice for the banks to back off some of those debts?

    I had a 2nd home I was renovating for sale and, for a while, had a bad cash-flow and had to maintain a balance on my credit card. It was amazing how fast they found out I had retired! My Discover Card was suddenly 32.99%, though it only took a 60-second phone call to reduce it back to 3.99%. Similar games were played by my other cards. I'm now in a debt-free position where I should never need to have ANY debts at all in the future - I expect to pay cash for any cars.

    So what happens? I get calls from Discover and Citi-Mastercard wondering why I'm not using my cash-back cards more. They tell me I should be buying groceries, gas, etc. with them. Of course, they reason these phone messengers are employed is that the Card companies hope to both grab a little more of the businesses' sales and hope I overdo it and have to carry a balance. We're encouraged to charge it!

    I've personally gone back to paying cash for as much as is practical -even walking into the gas station to pay instead of swiping my card anymore. I puts more of a brake on my excess spending to see cash disappear from my wallet than by charging everything.

    I can just imagine the frustration for those who run up small debts they think they can pay, then suddenly find the monthly interest jumps to $200 from $30 for the same balance and not have assets eventually come riding to the rescue as in my case. If true justice existed, those so-called "sacrificing" bankers would be imprisoned for life because their Congressional contributions allow them the laws to legally steal more money than any 100 imprisoned thieves.

  • Report this Comment On August 08, 2010, at 10:20 AM, lctycoon wrote:

    How about comparing the consumer debt numbers against the National Debt? I think you'd find that a lot of the consumer debt that has supposedly been paid off has in fact, just been moved to the government's liability side of the balance sheet. That still sucks cash out of the productive economy and hinders a rebound.

  • Report this Comment On August 08, 2010, at 10:52 AM, ragedmaximus wrote:

    Think about this if you were to take the average amount of interest rate that credit card sharks charge and we the public could get we would be rich in no time due to compound interest .Now if you take reality and take the same amount of debt and add the average interest rate that credit cards charge =AMERICA POOR!

  • Report this Comment On August 10, 2010, at 12:45 PM, Deepfryer wrote:

    Great article. It won't be an easy recovery, but the situation is clearly getting better.

    On the other hand, if we enter a period of deflation, then those "debt service payments" will represent a much larger burden - even if the numbers don't show an actual increase.

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