Households Deleverage Themselves

This space has carried other stories on consumer finance, but the deleveraging that has occurred among households is so significant to the economy that it deserves discussion from many angles. The change in household finances has, in fact, done nothing less than create what might be described as a Goldilocks situation for the economy – enough growth to sustain the admittedly slow pace of this recovery but nothing excessive that might lead to a recession.

The financial behavior of households since the financial crisis is unprecedented in the last 75 years. Federal Reserve statistics show that overall household debt in the United States by 2013 had fallen nearly a trillion dollars from its peak of $13.3 trillion in the second half of 2008. Debt levels have grown since but at an atypically slow pace. They remain, as of early this year, still more than $620 billion below peak levels. Most of the decline occurred in mortgage debt. Originations remained extremely subdued between 2009 and 2013, especially relative to pre-crisis levels, while charge offs, mostly from foreclosures earlier in the period and accelerated payments later on, were dramatic. The change was not all in mortgages, however. Between 2008 and 2010, households cut back on auto debt, credit-card debt, and all other forms of debt, except student loans. Since, the growth has remained so subdued that the outstanding amount of consumer debt in 2015, including student debt, barely exceeded levels of early 2008.

Less dramatic but perhaps more significant is how households, even as they have begun again to use debt, have kept the growth well contained. Indeed, they have proceeded so prudently that debt growth has trailed income growth by a significant margin. At its peak in 2007, outstanding household debt of all kinds exceeded annual flows of household income by 24 percent. With declining debt levels and admittedly very slow income growth, households were able to bring this measure of leverage back toward even by 2012. By keeping debt growth slower than income growth since, households have brought this leverage measure down further. As of the first quarter of 2015, the most recent period for which data are available, outstanding household debt of all kinds stood at only 95 percent of annual income flows, lower than any time since the late 1990s.

This prudent behavior may keep the overall pace of economic growth slower than if households used debt more aggressively, as they once did, but it nonetheless has many favorable implications for the outlook. For one, it leaves the household sector more resilient than in a long time should it face a financial shock. The relative lack of leverage also speaks to the absence of any excess that would prompt a correction in the household sector, 70 percent of the economy, and possibly lead to recession. If the prudence on debt use has kept this recovery slower than it otherwise might have been and will keep it slower than historical norms going forward, it does point to a more durable, secure recovery than otherwise.

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