Can we talk about debt?
U.S. consumers have way too much of it. It's likely the single biggest reason the economy is so slow. Ten years ago, the economy was powered by people taking out a second mortgage to buy more stuff, which increased employment for people who made and sold the stuff, who rang up their credit cards to buy stuff themselves, and so on. Today all of those people are trying to figure out how to repay that debt, which brings everything to a halt.
The good news: Households have been shedding debt for several years. And that so-called deleveraging is continuing at a good clip.
The Federal Reserve released this chart a few days ago showing exactly how much debt has been chipped away:
Household debt has declined by $1.3 trillion since the peak in 2008. That's made up of a $300 billion rise in student loans, and a $1.6 trillion fall in all other forms of debt (mostly mortgages).
There are better ways to look at this that make the decline look even more impressive. What matters when measuring debt isn't the raw amount, but the amount of debt in the context of income. Take the same chart above and divide it by disposable incomes, and you'll see that the debt-to-income ratio has declined about 18% since the previous peak. It's now at the lowest level in a decade:
Source: Federal Reserve.
And with interest rates at all-time lows, the monthly payments required to service all the debt households own has dropped, too. Look at debt-service payments as a percentage of disposable income, and you get this:
Source: Federal Reserve.
The lowest level since 1994. With the majority of household debt being in the form of mortgages, and 30-year mortgage rates at an epically low 3.6%, the relief for the millions of Americans who have refinanced (truth be told, millions more can't) has been drastic. And since a good bulk of those refinancings are in long-term fixed-rate mortgages, this is permanent relief.
Whenever the topic of deleveraging is brought up, someone inevitably points out that a lot of the decline is due to people defaulting on debt rather than paying it off. My response is always, "So what?" They're getting rid of the debt, and it's the bank's problem to figure out how to deal with the loss. But there's more going on here than just defaults. A separate Federal Reserve report shows the amount of consumer debt outstanding fell from 2008 to 2010 even after defaults are stripped out -- an outcome caused by people actually paying their debt down. And while the figure is now back in positive territory, the amount of new debt being accumulated per quarter, net of defaults, is about half the amount it averaged last decade.
The most important question is how much more deleveraging needs to take place, and how long it will take. A McKinsey report from January estimated that households could be done deleveraging by the middle of next year. That could be optimistic. Some simple calculations show the economy as a whole could be deleveraging for another decade. The truth is, we don't know when it will end. The amount of debt households can maintain is largely built on how confident they are about the future. That can't be predicted or modeled. Unemployment also plays a big role -- another trend that can't be predicted with confidence. But here's the good news: We're definitely moving in the right direction.