Debt to Income Ratios and the U.S. Savings Rate

by: TraderMark

Many discussions of the mountains of debt in the US center around this now infamous chart. This one has data through Q1 2008, I am sure there are more updated versions.

While credit market debt to GDP might be useful to a country as a whole, more interesting to me is looking at data on a household basis. In a post over at FTAlphaville, Credit Suisse Chief Global Strategist Jonathon Wilmot has posted some data breaking down household debt by decile. Apparently the chart somehow sings to him a bullish case; one I could not discern after re-reading the logic a few times, but I thought the chart was so snazzy it was worth bringing over to show the scope of the damage that has been happening under the surface the past 2 decades. (click to enlarge)

What I would like to do is to take a step back and look at the larger trend and why this helps explain some of my thesis on how much trouble the bottom 80% of America truly is, and why I was so adament that once the house ATM was gone this economy was going to crumble. [Dec 8, 2007: Do the Bottom 80% of Americans Stand a Chance?] (Frankly, things got much worse than even I anticipated.)

Obviously there were some massive cultural shifts in thoughts on spending, saving and attitude (entitlement) that happened sometimes in the 1980s forward; about the time the baby boomers entered their peak earning years. The data set above only begins in 1989, I wish it would have gone back one decade further to see the change since 1979. Either way, what we can see are 6 lines representing US households, of which there are roughly 111M, so throw 11M households in each decile.

For reference I headed to the census section of the federal government's website and came upon this pdf which shows some ranges of "who" fits into these deciles; this should help you better grasp whom we are speaking of in each of these groups. Again let me stress these are households, not working adults. Using 2007 data (incomes went down in 2008) since that is how far the series above goes to...

  1. 90th percentile is any household making > $141,000
  2. 80th percentile is below $141,000 but above $104,000
  3. 50th percentile = $52,000
  4. 20th percentile = $21,000
  5. 10th percentile = $12,600

I would suggest that most people who are reading an investment blog on a regular basis who are not students, live in a 70th-ish percentile household or above - unless single. Anything in the 10th percentile fulfills even the government's very stringent definition of poverty, whereas I'd argue anyone in the 20th percentile is also very poor off by any common sense definition, considering the high cost of living in the States.

So let's head back to the 2nd chart above. What I find remarkable is how almost all Americans in the late 80s started from a very similar area. Everyone aside from the top 10% began in a narrow band somewhere in the range of 80-90% debt to income, even the worst off Americans. The top 10% were somewhere in the 60% range.

1) So what happened 2 decades later? A tsunami of debt across all groups. Most of the income and wealth growth has been achieved in the top 20%, especially in the top 5% (in fact, top 2%) of Americans the past few decades. As their wealth exploded their debt has moved in line, so in raw numbers much higher debt but as a % of income relatively stable. This group, those households over $141K, therefore is not interesting to analyze.

2) Let's move to the bottom 20%; those households making $21,000 or less. They have been afforded much more ability to access credit as "financial innovations" from our oligarchs were unleashed, along with the huge growth in payday loan centers across the American landscape the past decade. Government programs to a lesser degree also apply here. Coming from a starting point of debt to income no different than those income groups above them (the 21st-90th percentiles) in 1989, their debt to income ratio has almost quadrupled in 20 years. With many of these folks on government programs for income or in the lowest paying of our service jobs, there is really no hope to service that debt. Much of it will be in default over time.

There will always be "poor" in any society, and ours have been encouraged to get what they "deserve" - and many have been afforded very little financial education as to the consequences... after all it is America and we all deserve the best. Cable TV, cell phones, the luxuries of a 1st class modern society - all a birth right, if you can afford it or not. To argue that point would be to say that attitudes have not changed about "what is deserved" since the 1980s... they have. People, even in the toughest economic deciles, did not used to act like this - as the data above clearly shows.

3) The truly fascinating portion of this chart lies in the parts not represented by the upper 10% (>$141K) or lower 20% (<$21K), but the other 70%. These are represented by 4 distinct lines above, but have moved as one monolith in the past 2 decades. After all, 4 of these groups began in that 80-90% debt to income ratio range in 1989, and all have essentially doubled their debt obligations in 20 years.

This is our great "middle," 70% of American households - all moving in lockstep .... once more unleashed to easy money via credit cards, government programs, an "ownership society" mantra that meant even people with no savings could own homes, as well as easy money policies by a central bank gone insane. Secular and cultural factors I would attribute this to are in part: a combination of entitlement, keeping up with the Joneses, lack of long term planning, conspicuous consumption en vogue, lack of financial education at any step of the American schooling process, the "house ATM" as piggy bank, and a lack of wage growth to service said debt that the "median" worker has enjoyed the past decade as globalization hits the (NON government / healthcare / education) masses.

Solutions? They are happening as we speak. (1) The govenrment (which means fellow taxpayers, and / or future taxpayers) is providing income to Americans at a level not seen since before the Great Depression [Jun 5, 2009: 1 in 6 Dollars of Income Now Via Government; Highest Since 1929], subsidizing our home purchases, subsidizing our car purchases, heck even appliances, (2) the central bank is debasing the value of this debt, to the tune of a 40% drop in the dollar since 2003 and (3) Americans are walking away from their debt, either by choice or not ... bankruptices, not paying mortgages [Nov 25, 2009: America's Stealth Stimulus Plan: Allowing its "Home Owners" to be Deadbeats], you name it. As I facetiously say, if all Americans just declared bankruptcy, you can imagine a few years of 30% GDP growth .... but in the interim the central bank is furiously working to "fix it" through money printing, and the federal government is handing out what it can before our foreign creditors can escape.

This toxic combination of 3 factors above should really be called the United States of Irresponsible.

In conclusion, charts like this above show why anyone who over thinks the stock market will drive themselves crazy. None of our root causes have been solved, we are simply paper printing ourselves to prosperity (and a higher stock market) and continuing to live in our Alice in Wonderland existence.

As an aside, I have the sort of "inverse" of the charts above, in the post here . [Dec 29, 2008: What Happens if America Returns to a Historical Savings Rate?]... speaking to why the US savings rate needs to return to normal for any chance of getting out of this mess through any means other than debasement of currency. Obviously as a nation we have decided saving is not going to be the way we go... it's too 'hard' and 'unfair,' so debasement it will be.