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.
Incoming!
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.
