Consumer Deleveraging: The 'New Fru' Is for Real

by: James Bacon

Click to enlargeConsumer deleveraging proceeds apace, but the debate still rages: Have American consumers mended their ways? Are they truly cutting back on their borrowing and spending, or do measures of indebtedness reflect little more than banks writing off billions in bad loans?

The Federal Reserve Bank of New York has compiled an impressive body of evidence to suggest that the "new frugality" is real. The bank's Quarterly Report on Debt and Credit for the third quarter of 2010 shows that United States consumers have pared nearly $1 trillion from their outstanding debt since its peak in the third quarter of 2008.

While defaults and charge-offs contributed to the decline, says Donghoon Lee, senior economist, "Americans are borrowing less and paying off more debt than in the recent past." The change, he suggests, comes from both tightening credit standards and voluntary changes in spending behavior.

Consumers reduced their cash flow by $150 billion to pay off debt in 2009, compared to borrowing $300 billion annually to augment consumer cash flow between 2000 and 2007.

Excluding the effects of defaults and charge-offs, non-mortgage debt fell for the first time since 2000. In addition, mortgage debt paydowns reached $140 billion by year-end 2009. "These unique findings suggest that consumers have been actively reducing their debts, and not just by defaulting," states the press release accompanying the report.

Consumers are serious about paying down debt and bolstering their savings. The accomplishment is all the more remarkable coming during a time when nearly one fifth of the population is unemployed or underemployed. The trend will continue for at least a few more years as boomers, who have only a few years left to accumulate wealth, get serious about saving for retirement. Consequently, the U.S. growth rate will be sub-par for several years to come.

The bottom line for Boomergeddon: For us debt and deficit watchers, that means (all other things being equal) higher deficits and more debt than that estimated in the official budget projections. The new Congress may be serious about cutting government spending, but it will be paddling against a current of slower growth and disappointing tax revenues.

Disclosure: No positions