Are Households Still Deleveraging?

by: Tim Duy
Calculated Risk reviews a David Leonhardt New York Times article and notes:

In addition, household debt as a percent of income, remains very high and household deleveraging is ongoing. That is why so many companies identify their number one problem as "lack of customers"…

The picture looks like this:

How much deleveraging is left remains a mystery. Just to the pre-2000 trend, or even farther? Or is the process pretty much over? Steve Matthews at Bloomberg recently wrote a story full of anecdotes and quotes from those who believe we are very far along on the deleveraging story. Some examples:

…“The financial situation of the household sector has improved far faster and far more than everyone thought it would two years ago,” said James Paulsen, chief investment strategist for Wells Capital Management in Minneapolis. “People are still locked into the view that consumers are facing record burdens, and they are not. There has been a change that is sustainable and durable.”…

…“The household deleveraging process is much further along than is appreciated,” said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. “This is evident in the rapid improvement in credit quality. ‘Zombie consumers’ is a mischaracterization of the state of the American consumer.”…

… Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York, says the growth in credit reflects an underlying optimism, part of a virtuous cycle. As a Fed economist in 2000, he published research that concluded “high debt burdens are not a negative force” and the debt-income ratio isn’t reliable in predicting spending…

The picture that tells this story is this:

Household financial obligations – the ongoing service costs – have plunged since the beginning of the recession. By this view, it is not the level of debt relative to income that should be the concern. Instead, we should be looking at the cost of financing that debt. And that cost steadily decreased since the 1980s as interest rates fell, allowing households to steadily increase their debt levels while financing costs were constrained.

For me, I can see both sides of this story, but keep coming back to this chart:

If households are trying to deleverage their way back to a net worth position of 470% of GDP, I imagine the period of deleveraging is only just beginning. Consider years of cutting debt while hoping asset values rise sufficiently to pull you out of the post-bubble hole - all the while a mediocre economy ensures building assets is difficult at best.

But aside from the deleveraging question, another takeaway from the last chart always rattles in the back of my head: It sure looks like asset bubble-induced surges of net worth were critical in maintaining full employment during the past decade. And we aren’t coming close to filling that hole with other spending. Which is why we keep getting this picture:

and this picture: