Household Deleveraging: Still A Long Way To Go

Here is a quick look at a potential trend towards households shedding debt:

From the WSJ:

Deleveraging has more to go.

Just how far could become clearer when the Federal Reserve releases fourth-quarter flow-of-funds data Thursday. The third quarter marked the first decline in household debt since recordkeeping began in 1952, fueled by a record 2.4% drop in mortgage debt.

Debt likely shrank even faster in the fourth quarter. According to already-released Fed data, non-mortgage consumer credit fell at a 3.2% annual rate. Another decline in mortgage debt, which is four times as big as non-consumer debt, is almost certain, given the collapse in sales and home-equity extraction, as well as surging loan delinquencies and defaults.

Shedding more debt would be a healthy thing, since household debt levels in the third quarter were equal to 96% of gross domestic product and 130% of disposable income.

The trick is figuring out just how far this deleveraging should go. There is “no magic number,” suggests T. Rowe Price chief economist Alan Levenson, but one benchmark could be 1998, when foreign savings began to rise. Back then, the percentage of household income spent satisfying creditors was less than 12%, in line with the long-term average, compared with a near-record 14% now.

Household debt was just 66% of GDP in 1998; and returning to that level would entail a 30% plunge in debt. That may be too extreme, particularly if the U.S. homeownership rate keeps a floor under mortgage debt, despite declining from its 2005 peak.

Suffice to say that consumer debt ratios will likely keep falling. An income boom would do the trick painlessly, but that seems unlikely. Otherwise, consumer spending will slow, keeping pressure on the financial sector, which is shedding debt much more slowly than households.”

Graphic courtesy of the WSJ

While the debt levels of 1998 may be difficult and painful to achieve, I think it’s something we need to shoot for because the current situation isn’t sustainable. Debt loads that represent 130% of a typical household’s disposable income are just a recipe for disaster, but in terms of present day solvency and people’s ability to save for retirement.

However this is all easier said than done because a large portion of our nation’s GDP over the past ten or so years has been fueled by credit, and if you remove credit from the equation you have to find a way to replace the lost economic activity. While I don’t have the answer on how to do that I do know this: propping up an unsustainable model is not a suitable alternative.

For more from the WSJ’s “Ahead Of The Tape” click here.

Source:

The WSJ: “Deleveraging: It’s Not Over Till It’s Over” —   Jeff D. Opdyke, March 11, 2009.

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

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