Koo: The Balance Sheet Recession Is Not Over

by: Cullen Roche

There has been a lot of talk in recent months about the end of the deleveraging cycle in the U.S. Richard Koo, who coined the term "balance sheet recession" to describe the deleveraging cycle, isn't buying it. In his latest note, he describes why the U.S. has years left to go. He says (see the accompanying chart via FT Alphaville for the details mentioned here):

If people who had been paying down debt to repair their balance sheets had actually resumed borrowing, it would mean that balance sheet problems were behind us. However, the fact that the latest colored bar in Figure 1 is above zero indicates that US households are still paying down debt.

Inasmuch as this act of reducing financial liabilities in spite of zero interest rates runs counter to the principle of maximizing profits, it suggests that U.S. households continue to undertake balance sheet adjustments.

I think Koo's view is confirmed by the N.Y. Fed's latest data on quarterly household debt trends. They showed another quarter of de-leveraging. But the balance sheet recession isn't an event. It's a process. And the process is very clearly moving in the right direction. For instance, see the improvement in consumer borrowing year over year:

We're obviously digging out of a deep hole there, but we're digging. Household debt is on the verge of turning positive. There's still a lot of work to be done here and the recovery remains fragile, but we're moving in the right direction. I had previously estimated that the balance sheet recession could be over by 2013/2014. That could be a bit optimistic if you consider "the end" a return to historical trend debt accumulation of about 7%, but we're moving in the right direction. Just one more reason why it's so important for the government to remain supportive of very weak private sector trends here.