What Does The Graying Of American Debt Mean For You?

Includes: DIA, IWM, QQQ, SPY
by: ColoradoWealthManagementFund


Research from the Federal Reserve demonstrates significant changes in the composition of debts across America.

There were several important trends that could be analyzed to assess the implications of this change in debt.

The increase in student loan debt should indicate stronger levels of “human capital”, but an inability to qualify for mortgages suggests otherwise.

The Cobb-Douglas formula can be simplified for assessing GDP growth per person and clearly identifies the major problems.

The high earnings multiples for the stock market appears to be a response to low bond yields since economic fundamentals remain challenged.

The Federal Reserve of New York runs a blog titled: "Liberty Street Economics". The blog is of interest for anyone wanting to understand more about the economic environment and the way debt and interest rates influence it. In late February they released an article on "The Graying of American Debt". The piece is excellent from an academic standpoint because the data is organized effectively and the charts are perfect for delivering the message. All figures cited are adjusted for inflation to reflect the CPI in 2015. The only weakness for the article is the relatively light level of conclusions reached regarding the implications for macroeconomic growth. That makes sense since the Federal Reserve may want to avoid the risk of going too far into the realm of subjective commentary.


Data was compared for 2003 and 2015 to determine the relative differences in the debt profile across age groups. That might seem dry at first, but the implications are very interesting. In this piece, I will be focusing on those implications. By its very nature, this is the subjective commentary and analysis that the Federal Reserve might be hesitant to produce.

There are five categories for debt: Mortgages, HELOC (Home Equity Line of Credit), Student Loans, Credit Cards, Auto loans

That sums up all the introductory information that is necessary, so we can dive into the trends and what they mean.

Important Trends

There is a shift towards higher average debt balances among older Americans (per capita).

There is an increase in the percentage of Americans that are in older age brackets. This amplifies the impact of higher average debt balances among older Americans.

Debt for older Americans increased in 4 of the 5 categories. The only one that did not increase was credit card debt.

Debt for younger Americans decreased in 4 of the 5 categories. The only one that increased was student loan debt.

Starting from the age of 20, all age groups have at least twice as much student loan debt in 2015 as they had in 2003. In some cases the growth is significantly larger.

Simplifying Economic Growth - GDP

While Liberty Street Economics' conclusions largely focused on the expected reduction in defaults, they did little to address the challenge for GDP growth. That is unfortunate because GDP growth is a critical element here. The goal of the Federal Reserve is to manage unemployment and inflation, but the purpose of controlling those elements is to encourage GDP growth. To establish a better standard of living for the citizens of a country it is important to grow GDP per capita over time.

For instance, the impact of high unemployment is a waste of human hours that could have been used to produce goods and services. The impact of fluctuations in inflation is an increase in the risk premium demanded on investments. Since a higher risk premium discourages investments, it can be a barrier to growth.

Organization of Analysis

With the trends established and the goal of analysis (assessing future GDP growth) established, I would like to analyze the individual trends and what they mean for investors.

Implications of Higher Average Debt Balances Among Older Americans

The trend towards higher debt balances by older borrowers appears favorable to banks since the credit scores of older borrowers are higher on average. This would suggest a lower default rate. That doesn't tell us much about GDP growth though. Remember that as individuals and families we still have our own financial statements. Even though most people rarely assess their financial statements, the reality still exists. A shift towards higher levels of average debt would either need to be offset by an increase in assets or a decrease in equity. Unfortunately, measuring the value of assets and equity is dramatically more difficult than measuring the amount of debt (or liabilities).

I believe the most likely case here is a decline in the average amount of equity. This creates a challenge for the next generation because it indicates lower levels of inheritance. All else equal, it would seem that the weaker balance sheets of the older generations will translate into weaker balance sheets of the younger generation. This is a headwind for consumption over the next 20 to 30 years.

Percentage of Older Americans

The increase in the percentage of older Americans creates another wrinkle. Since Social Security is willing to use current incomes to pay current expenses a decrease in the level of working adults per retired adult means that either inflation adjusted payouts to retired adults would decrease or the payments into the system by younger adults would need to increase. Absent significant growth in GDP per person, it is unclear how this cost would be covered. For the near future this isn't a major problem, but analysts looking at a business that was drawing down the assets would be significantly concerned.

Older Americans and the 5 Categories

The following chart demonstrates the average debt balance per person for borrowers at each age. This is an incredible level of detail since it breaks down the sources into the five categories. It is important to recognize that there are two Y-axes (yes, the plural of axis is axes). The left axis is used for mortgage debt and the right axis is used for all other kinds of debt.

The one positive here is that credit card did not "increase" for older borrowers. At some ages the value appears to be higher and at some ages it appears to be slightly lower. The positive aspect here is that credit card debt carries higher interest rates and if credit card debt was increasing for older Americans it would reinforce the theory of a weaker balance sheet since presumably retirees would have the wisdom to pay off their credit card balance with equity.

Since credit card debt is the one category that did not climb, it provides some hope that the balance sheets are doing better than it would otherwise appear.

Younger Americans and the 5 Categories

I believe this is the most interesting and influential of the figures, yet it received very little discussion. Debt levels are materially lower for all categories except student loan debt. Since total debt levels in the first chart were demonstrated at relatively similar levels for younger people, it would be easy to dismiss this as a change in the composition of the debt and to believe that it is favorable since "investments" in education should improve future productivity.

That conclusion completely ignores any change in the value of the degree over time. In simple terms it is confusing value and price. I believe we can all agree that the price of a college education has increased dramatically faster than inflation over the last few decades. While college graduates have higher expected earnings than peers that do not graduate, assuming the entire difference is due to the degree is confusing causation and correlation.

Rather than seeing an increase in student loan debt as indicating more "investments" in the future, I see an increase in student loan debt as an increase in debt that is not backed by physical assets. Lack of mortgage debt is not a sign of young people having a healthier balance sheet or income statement. It is a testament to the challenges they face in being approved for a mortgage. Consequently, it indicates a lack of building equity.

A substantial increase in the amount of student loan debt would appear sustainable if it was correlated with an increase in the percentage of young people with mortgage debt. If degrees were leading directly to jobs where new graduates could earn enough to qualify for a mortgage, then there would be some compelling evidence that "investments" in their education were paying off. Instead, the inability to qualify for mortgages and increase in young people living with their parents suggests that students (measured in aggregate) are paying higher prices for their education and receiving less value.


While the graying of American debt indicates lower expected defaults for the banks, a deeper look indicates problems for future GDP growth. Assessing all college debt is a sign of greater investment in human capital is a failure to recognize the disconnect between price and value. The decrease in key areas such as mortgage debt for younger Americans is indicative of their investments in "human capital" failing. If those investments were paying off, the increase in investments would correspond with an increase in wages and equity.

The Cobb-Douglas function demonstrates growth in GDP as being equal to the multiplication of growth in TFP (total factor productivity), labor input adjusted for elasticity, and capital input adjusted for elasticity. If we want to look at GDP per person and assume that labor hours per person were not going to change, then the formula would simply require TFP and the capital input adjusted for elasticity. This is all simpler than it sounds. The Federal Reserve is pushing down interest rates to encourage lending so that business can invest in growing their productivity capacity. Theoretically this would result an increase in the capital input which would grow GDP per person. The exact amount of the impact would depend on the elasticity, but the simple premise remains true. Unfortunately, the Federal Reserve's strategies are severely limited by companies using debt to repurchase stock rather than to invest in new physical assets.

Without the capital being invested in new physical assets that can be leveraged to produce more goods and services, the only part of the equation left for boosting GDP per capita is TFP. The logical argument for supporting loans to finance education relies on greater education leading to workers that are more capable and able to raise TFP. If we were seeing the investments in education lead to strong wage growth for younger earners and an increase in their ability to take on mortgage debt (rather than return to live with their parents), it would suggest that young workers were successfully carrying the burden.

Instead, the most logical interpretation of the change in the debt structures is to say that GDP growth per person is facing severe headwinds as neither TFP nor capital inputs appear likely to rise significantly. Further, the headwind facing GDP growth suggests that the strong earnings multiples on stocks is primarily supported by the exceptionally low yield on bonds rather than by reasonable expectations for strong economic expansions.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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