Parsing the Household Debt Load
Industry News

Source: Collections & Credit Risk

Driven lower by heavy charge-offs and increased frugality among consumers, inflation-adjusted household debt, including borrowing on credit cards, has fallen about 5.6% from a peak in the fourth quarter of 2008, to a nominal $13.4 trillion in the second quarter this year.

For one key measure of the health of household balance sheets, however, another factor has been as important as the combined force of writeoffs of by lenders and greater circumspection among borrowers. The ratio of debt to net worth peaked at about 28.2% in the first quarter of 2009, just as the value of household assets reached a trough.

Inflation-adjusted assets subsequently recovered by 5% through the middle of this year, according to data from the Federal Reserve, and the ratio of debt to net worth improved by 3.1 percentage points, to 25.1%.

In fact, for the past 15 years, changes in debt-to-net-worth ratios have been mirror images of swings in asset values prices have moved faster than households have been able to build up or shed debt. Home values soared without interruption for the better part of 10 years, but the stock market tumble at the beginning of this decade added a hump to the picture.

Of course, the recent asset and debt bubbles were conjoined phenomena. Rising prices allowed homeowners to borrow ever-larger amounts against real estate while ratios of mortgages to owners' equity stayed about flat through the middle of this decade, and the rising tide of debt chased prices higher.

Now, vast debts have been left behind after the foundations that supported their accumulation have crumbled, and an uncertain economy and forecasts that home values will not appreciate substantially for years make it seem unlikely that asset prices will fuel a rapid, sustained rehabilitation in debt-to-net-worth ratios.

The ratio of home mortgages and other consumer debt to after-tax income also remains well above historical norms, though the decline in borrowing has lowered it 12.8 percentage points from a peak in the third quarter of 2007, to 110.8% in the second quarter this year, as disposable income, propped up by stimulus measures, has inched up.

Perhaps a more optimistic picture emerges from the Fed's estimates of the amounts households have to devote to service debts (both interest and periodic principal payments) and other basic obligations like rent as a percentage of disposable income. Since peaking at 18.9% just before the onset of the recession, the ratio has fallen more steeply than debt-to-income, presumably reflecting lower interest rates in addition to reduced borrowing. While low interest rates are unlikely to persist indefinitely, at 17% in the second quarter, the measure has dropped to levels last observed more than a decade ago.

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