Deleveraging

by Dave Schuler on November 27, 2012

The question that occurred to me in reading Bill McBride’s most recent post in which he noted a report from the NY Fed that indicated that consumer indebtedness had declined .7% from the second quarter of 2012 to the third quarter of 2012 was is that good news or bad news? You be the judge.

I did a little back-of-the-envelope calculation and found that, if consumer indebtedness declines at that rate until it reaches its level in the first quarter of 2003, that would take 57 quarters, just shy of 15 years. A quick check of the history suggests that we have never experienced a decline of that length. Indeed, the history of the post-World War II United States, the period of our greatest prosperity, is one of ever-greater expansion of consumer indebtedness.

Now, admittedly, my model is pretty simple. I’m ignoring things like inflation and the effects of future recessions.

However, if what we’re experiencing is a balance sheet recession, household indebtedness declines at the rate that it did in the report, and the magic target number is the level of indebtedness we had in 2003, it looks to me as though we have a problem. The problem is that much bigger if the magic number is the level of, say, 1993. Or 1983.

{ 40 comments… read them below or add one }

PD Shaw November 27, 2012 at 3:28 pm

The primary component of “de-levereging” here is in real estate. That could easily reflect continuing problems in the housing market. It could mean fewer first time buyers, either because they have lower demand for home ownership or cannot get credit. Meanwhile, the existing homeowners are not moving as much as they used to and some of them are taking advantage of re-financing.

I’m surprised total credit card debt is almost a tenth of total auto debt. I’m not sure why; I would think credit card debt would be higher.

PD Shaw November 27, 2012 at 3:33 pm

To be clear here. First time buyers not leaping into the housing market as early in life might be good for them. Its not necessarily good for the housing market, which has grown to depend on churning of ownership. I don’t know that house prices have dropped sufficiently yet in many parts of the country.

PD Shaw November 27, 2012 at 3:47 pm

Or, I should add, mortgage reductions are the result of mortgage foreclosures. The mortgages are being eliminated and housing values written down.

Sam November 27, 2012 at 4:00 pm

Some adjustments in the positive direction of your pessimistic analysis:

1. if 2003 is the magic year, then I think nominal debt / nominal gdp is the right indicator to use. This is just debt to income ratio and doesn’t account for 2.

2. interest rates are lower which makes the burden of the same debt in dollars more manageable, so something more realistic might be when we achieve the same debt service / income ratio of 2003.

3. Another positive related to (2) – given tight lending standards, overall debt is likely shifting to higher income households which would positively affect the debt service/income ratio.

Dave Schuler November 27, 2012 at 4:14 pm

given tight lending standards, overall debt is likely shifting to higher income households which would positively affect the debt service/income ratio

The dirty little secret of the household debt issue is that by far the greatest amount of household debt has been held by people in the top quintile of income earners for years. That’s actually pretty easy to understand. People in the bottom quintile don’t buy or finance million dollar houses.

And I don’t think that my analysis is pessimistic, just sobering. I’m merely pointing out the necessary concommitants of the assertion that we’re in a balance sheet recession and the rate at which deleveraging is occurring. We’d better hope that it wasn’t a balance sheet recession or else we need to be deleveraging much, much faster than we are. I don’t see any way that can happen without federal prodding.

steve November 27, 2012 at 5:04 pm

Federal prodding? Fiscal policy was possible in the 30s since they entered with low levels of public debt. Forcing write downs of mortgage debt? I have no idea if the banks can take this yet. Not sure if it is politically possible. What else do you have in mind? (Debt had been dropping faster until that quarter.)

I guess export growth remains possible, but the EU is going into recession, and China slowing down. Growth is how we have gotten out of this kind of problem in the past, but I dont see where that is coming from. Suppose Obam is impeached and we put a GOP demigod in office. All of those businessmen feel appreciated and start investing like crazy. Where do they get that money, and do we really need them debt financing another expansion just like they have all of the others since 1980? Where does the consumer get the money to buy? I just dont think there is a quick and easy way out of simultaneously running up private and public debt, especially private.

Steve

Dave Schuler November 27, 2012 at 5:09 pm

Debt had been dropping faster until that quarter.

And even at that rate it was intolerably slow. A dozen years is a good part of a career, a working life.

If the banks can’t stand it, they should fail. And we should deal them the way that Sweden did when they had their banking crisis.

An additional factor that needs to be mentioned: deleveraging is a perfect use for Ben Wolf’s perennial suggestion—just spending the money into existence. Mark to market and then buy up the paper with other paper.

Or we can lie around in the doldrums for the next dozen years.

Janis Gore November 27, 2012 at 5:30 pm

I know retail. There’s something like a 65% markup when an item goes on the floor. I worked at Lady Marlene in NYC for a while.

They strapped Ann of Sugar Babies into form for performing. Rag trade.

People pay too much for stuff they don’t need. Do you really need an Italian kitchen in Kansas?

Janis Gore November 27, 2012 at 5:34 pm

Do you need a granite countertop at the coast? Mind, that old 9-story building was built to a weight load. Granite is heavy.

I wondered about replacing carpet with tile.

Janis Gore November 27, 2012 at 5:36 pm

Too much money at some ends has trashed the American economy, I’m not afraid to say.

Janis Gore November 27, 2012 at 5:37 pm

One of the reasons I truly like Bunny Mellon. Wish I could meet her someday. She has beautiful gardens.

Janis Gore November 27, 2012 at 5:39 pm

Thorsten Veblen, again. Daddy hounded that into me.

Janis Gore November 27, 2012 at 5:47 pm

Home economics counts.

Janis Gore November 27, 2012 at 6:08 pm

I bought a frickin’ Armani 4-piece suit on consignment for $400. It cost $24 to have the jacket altered at the shoulder.

Janis Gore November 27, 2012 at 6:11 pm

Yes, chile, I can rise and descend to any occasion.

steve November 27, 2012 at 6:16 pm

Germaine to Sam’s point, debt service as a percentage of disposable income is at 1995, and close to 1980, levels.

http://www.washingtonpost.com/blogs/wonkblog/wp/2012/11/27/whats-holding-back-the-economy-in-10-charts/?wprss=rss_ezra-klein

Steve

Janis Gore November 27, 2012 at 6:25 pm

I’m wearing a nice french perfume:

http://www.luxuryperfume.com/sapphire-just-sexy-12836.html?utm_source=pricegrabber&utm_medium=ppc

When I don’t wear the Cerruti.

Janis Gore November 27, 2012 at 6:27 pm

Which was a gift from MIL.

Live well, die young, and leave a good-looking corpse.

Janis Gore November 27, 2012 at 6:35 pm

Donald Trump is such an asshole.

Janis Gore November 27, 2012 at 6:51 pm

We bought expensive teak parquet for the floors in our great room, from Thailand. We laid it ourselves and saved $4000.

Janis Gore November 27, 2012 at 6:54 pm

We could have done better now, because the grooves don’t stay clean. New engineered hardwoods are flexible. We had a hump into the kitchen to cover.

Dave Schuler November 27, 2012 at 6:59 pm

Germaine to Sam’s point, debt service as a percentage of disposable income is at 1995, and close to 1980, levels.

Then implicitly you’re arguing that it wasn’t a balance sheet recession.

Janis Gore November 27, 2012 at 7:00 pm

And that’s your home economics lesson for today.

Janis Gore November 27, 2012 at 7:02 pm

Americans are fat and stupid, for the most part.

Janis Gore November 27, 2012 at 7:03 pm

Oversatiated.

Janis Gore November 27, 2012 at 7:04 pm

I accredit to TV.

Janis Gore November 27, 2012 at 7:14 pm

Nobody is capable of making choices anymore. Lyman’s boys are prime examples. They either want too much, or they are incapable of asserting their will. It’s pathetic.

Janis Gore November 27, 2012 at 7:20 pm

Michael made damn sure he was out of town while we laid the laminate floor in the back bedroom.

Snotwad.

Janis Gore November 27, 2012 at 7:26 pm
Janis Gore November 28, 2012 at 12:15 am

Could’ve bought Amazon at $2.42.

Janis Gore November 28, 2012 at 12:21 am

My bet was on trucking.

Janis Gore November 28, 2012 at 12:27 am

But, y’all, we were conervsative.

steve November 28, 2012 at 2:33 pm

“Then implicitly you’re arguing that it wasn’t a balance sheet recession.”

Maybe, but it all depends on the record low interest rates we have. Have to think people know they are not sustainable.

Steve

Steve Verdon November 28, 2012 at 3:21 pm

Growth is how we have gotten out of this kind of problem in the past, but I dont see where that is coming from.

Technically you don’t need to see that. This is not a requirement. Really.

Steve Verdon November 28, 2012 at 3:25 pm

deleveraging is a perfect use for Ben Wolf’s perennial suggestion—just spending the money into existence. Mark to market and then buy up the paper with other paper.

Uhhmmm, no.

Well, not unless you want the U.S. to be like Wiemar Germany.

Steve Verdon November 28, 2012 at 3:45 pm

BTW, not sure, but what was the total consumer indebtedness in 2003? Or just point me to your source.

TastyBits November 28, 2012 at 4:15 pm


… Mark to market and then buy up the paper with other paper.

The debt needs to be written down, or the US can follow Japan.

There is no need to force mortgages to be written down. The financial institutions have capital requirements, and they must be solvent. Somebody thought it was a good idea to lend money to people who could not afford the payment, and this loan was secured by an overpriced house. It was not a good idea, and that somebody needs to learn that.

Steve Verdon November 28, 2012 at 4:17 pm

Nevermind followed the link.

If you look at debt-to-GDP. Assuming everything is in nominal dollars to get back to the 2003 level it will only take about 12 quarters with the following assumptions:

1. The 0.7% decrease is going to remain constant for that time period.
2. GDP does not grow.

If GDP grows it will take less time. For example, assuming that GDP grows by 0.2%/quarter then it will take only 8 quarters. So 2-3 years. Still a pretty long time for consumer debt to decline.

Unless you really think that total consumer indebtedness does need to fall by a total of 36.1%.

TastyBits November 28, 2012 at 4:24 pm

I think one aspect of the problem is quality not quantity. A mortgage on a house that can be sold with little or no loss is different from a mortgage on an underwater house. Also, a lot of people were using their house as an ATM.

Dave Schuler November 28, 2012 at 4:54 pm

A possible problem with your analysis, Steve, is what if GDP is being overstated (as I think it likely is)? Otherwise, I think you’re right.

This whole discussion highlights something I believe and that I think bugged me about the original Calculated Risk post. People should understand their own assumptions. Stating them helps in that.

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