American Household Debt Post 2008 Credit Crisis

Transcription

1 Insight. Education. Analysis. M a y American Household Debt Post 2008 Credit Crisis By Kevin Chambers 2008 was the worst financial crisis in the United States since the Great Depression. One of the factors that led to the severity of the crash was an unprecedented accumulation of debt by American consumers. Different factors contributed to the run up of consumers debt. Interest rates were kept artificially low by the Federal Reserve to combat the bursting of the Dotcom Bubble and the financial instability after the 9/11 attacks. The housing market was booming; the mortgage industry was using predatory tactics, and many American s had mortgages they could not afford. Between 2000 and 2008, the total debt of U.S. households more than doubled from $6.5 trillion to almost $14 trillion (Fig. 1). This is a story that we have all heard before, but what has happened to household debt since the credit crisis? Background First, let s start with a little bit of context for this subject. Household debt can be split into two general categories: secured and unsecured. Secured debts are loans that are protected by an asset such as a house, car, or boat. Mortgages, home equity lines, and auto loans are all secured debt. Unsecured debts are riskier as they do not have collateral to back the loans and usually have higher interest rates. Credit card debt, student loans, and personal lines of credit are all examples of unsecured debt. One constant prevails throughout the history of American debt: the majority of debt is collateralized home mortgages and auto loans. In 1962, 85% of total U.S. debt was in homes and vehicles. In 2001, the percentage was a comparable Fig. 1: Total Household Debt Outstanding Source: Federal Reserve Bank of St. Louis 408 SE 1 st Street, McMinnville, OR T: F:

2 Fig. 2: Percentage of Debt by Sector 90% (Campbell and Hercowitz 2006). Even through the 2008 crisis, the percentage of debt by sector has stayed fairly consistent with home mortgages making up 65%-75% of total debt (see Fig. 2). Because mortgages make up the majority of American debt, changes in mortgage regulations impact the debt landscape immensely. In the early 1980s, the Monetary Control Act and the Garn-St. Germain Act were signed into law by President Carter and President Reagan, respectively. This legislation led to a large restructuring of the mortgage environment (Campbell and Hercowitz 2009). The goal of the acts were to help savings and loan banks compete; however, both of the acts had little oversight provisions and it led to a rapid expansion of loans being issued by thrift banks. The next legislative shake up was the repeal in 1999 of the Glass-Steagall Act of 1933, which undid the legislation that had made it illegal for banks to combine traditional savings and loan activities with investment and insurance operations. This repeal lead to the creation of the mega investment banks that we know today (Sherman 2009). Relaxed regulation of financial institutions and falling interest rates led to the largest increase in personal debt in American history, and eventually, the crisis of Source: Federal Reserve Flow of Funds Fig. 3: Household Debt Outstanding as a Percentage of Personal Disposable Income One of the big changes since the 1980s was a large increase in the ratio of household debt to personal income. In 1980, just before the start of bank de-regulation, total debt was 69% as a percentage of disposable personal income in the United States. In the run up to the financial crisis, the debt-toincome ratio topped out at about 130%. The ratio was just above 100% at the end of This indicates that the rate of borrowing has outpaced the increase in disposable income. This is especially true after the repeal of Glass-Stegall. From 2000 to 2007, disposable income in the United States rose by 30%, while household debt rose by 50%, mostly due to the increase in mortgage debt (Fig. 3). Source: Federal Reserve Flow of Funds Page 2

3 Post Crisis The credit crisis put the growth in American household debt into perspective. Housing prices dropped, the recession took hold, and many families found themselves unable to afford their mortgage. As early as the 3rd and 4th quarters of 2009, the U.S. economy resumed a growth cycle, and financial markets showed strong positive gains. However, the growth of total household debt declined in 2009, 2010, and In the last two years, debt growth has been positive, albeit at a subdued rate. Debt increased by 0.2% in 2012 and increased by 0.9% in 2013, nowhere near pre-crisis growth levels (Fig. 4). Fig. 4: Total Household Debt Growth Sources: Federal Reserve Flow of Funds Delinquencies Fig. 5: Percentage of Total Debt Delinquent Sources: Federal Reserve Bank of New York Predictably, delinquencies and defaults had a sharp up tick after the crisis. From , an average 4% of total loans were delinquent. Delinquency rates grew through the crisis. By the end of 2009, 12% of all loans in the United States were delinquent. The distribution of delinquencies was not equal. Before the crisis, loans that were severely delinquent (over 90 days late) and loans that were days delinquent were equal at about 2% each of total loans. From , severely delinquent loans increased at a much larger proportion than delinquencies of days. Of the 12% delinquent loans at the end of 2009, 8.6% were over 90 days late. Although delinquencies have fallen through the recovery, severe delinquencies remain a problem. As of the fourth quarter of 2013, 5% of all loans are more than 90 days delinquent and 4.7% are more than 120 days delinquent, repossessed, charged off, or foreclosed (Fig. 5) Page 3

4 There has been a downturn in delinquency rates in recent years. From , the portion of severely delinquent mortgages has dropped 5%, credit card debt has dropped 4.3%, and auto loans have dropped 1.7%. Almost all types of loans have seen a drop in delinquencies after the crisis except one: student loans. In 2010, 8.7% of all student loans were over 90 days delinquent. At the end of 2013, this segment grew to 11.5% of all student loans. Student debt has grown over the same period from $760 billion to $1.1 trillion, an increase of 30%. This is partly due to a stunning 538% increase in tuition since 1985, but also due to a lack of understanding from borrowers (Nelson 2014). A Reduction of Total Debt Since the crisis, American s have generally been taking on less debt. From the end of 2008 to the end of 2012, American s have shed over $1.2 trillion of debt for a decrease of 11.7%. This decrease in debt across the country raises an interesting question. What caused the decrease in debt? Basically there are three reasons that could explain the decrease in household indebtedness (Brown, et al. 2010): (1) A reduction in debt by default (2) A reduction in consumer demand for debt (3) A reduction in the supply of debt The Federal Reserve System tracks charge-off rates of banks in the United States. This is the value of all defaulted loans written off of bank books, after they have reclaimed the value of any collateral as a percentage of average loans. From banks charged off an average of 2.2% annually. From the average rate rose to over 5%. This shows that a large portion of the decrease in debt can be attributed to banks writing it off of their balance sheets. Therefore, we can conclude that explanation number (1) was a contributing factor in the decrease in debt. Reasons (2) and (3) also contributed to the decrease. Their roles are intertwined. An economic study in 2013 (Mian, Rao and Sufi 2013) showed that households that lost the most wealth during the 2008 crisis had slower debt growth rates during the recovery. Was the slower growth rate a reaction by consumers to not repeat the mistakes of the past, or was the growth rate subdued because banks wouldn t lend to them? Gropp, Krainer, and Landerman (2014) empirically showed, using the difference between the debt growth of renters vs. homeowners, that more of the deleveraging process in the United States is due to a tighter supply of new loans, and not a lower willingness of American s to take on more debt (Gropp, Krainer and Laderman 2014). Some other studies have shown that some households avoided more debt to limit their exposure of losses; however, it seems the supply constraints on credit are more of a determining factor (De Nardi, French and Benson 2012). American s continuing demand for debt is still evident. In 2013, total household debt rose by $290 billion with a $241 billion increase in the fourth quarter, the largest quarter-to-quarter increase since Mortgages are up 1.5% in 2013, credit card debt is up 3.4%, and auto loans are up 8%. As the economy continues to improve, American s are taking on more debt. This will probably continue. The Federal Reserve has made it clear that they will try and keep interest rates low for as long as possible. Lower interest rates means it is more affordable to borrow money and outstanding debt should increase. The concerning ratio to watch going forward is the debt-to-income ratio (refer to Fig. 3, page 2). The congressional budget office expects subdued wage growth and stagnant Page 4

5 unemployment through Increased debt with little increase in income is worrying. The growth of student loan growth is also troubling. Over a third of the growth in debt for 2013 can be attributed to an increase in student loan debt. Going forward, the increase in debt for students can hopefully translate into higher wages to pay it off. Conclusion Debt is a necessary financial tool for most Americans, especially when it comes to home purchases. The most important factor when it comes to the amount of debt an individual can afford is their income. Good personal financial budgeting is essential. Hopefully, going forward, with new financial regulations and stricter lending standards, fewer people will be granted loans that they truly cannot afford. But if the amount of debt that is taken on by Americans is not matched with a similar growth in economic stability and income, we could be seeing the start of another credit bubble. Works Cited Brown, Meta, Andrew Haughwout, Donghoon Lee, and Wilbert van der Klaauw. "The Financial Crisis at the Kitchen Table: Trends in Household Debt and Credit." Federal Reserve Bank of New York, 2010: 3-6. Campbell, Jeffery, and Zvi Hercowitz. "Welfare Implications of the Transition." Federal Reserve Bank of Chicago, 2009: 2. Campbell, Jeffrey, and Zvi Hercowitz. "The Macroeconomic Transition to High Household Debt." Federal Reserve Bank of Chicago, Cornett, Marcia Million, and Hassan Tehranian. "An Examination of the Impact of the Garn-St.Germain Depository Institutions Act of 1982 on Commercial Banks and Savings and Loans." The Journal of Finance, De Nardi, Mariacristina, Eric French, and David Benson. "Consumption and the Great Recession." NBER Working Paper, Gropp, Reint, John Krainer, and Elizabeth Laderman. "Did Consumers Want Less Debt? Consumer Demand Versus Supply in the Wake of the Financial Crisis." SAFE Working Paper Series, Mian, Atif, Kamalesh Rao, and Amir Sufi. "Household Balance Sheets, Consumption, and the Economic Slump." The Quarterly Journal of Economics, Nelson, Deborah. "Student loan debt may stifle retirement savings." CNBC, May 8, Sherman, Matthew. "A Short History of Financial Deregulation in the United States." Center for Economic and Policy Research, Page 5