The Distribution of Households' Balance Sheets and the Recovery

by: Rortybomb

Mark Thoma Households’ Balance Sheets and the Recovery:

I still think tax cuts need to be part of a recovery package, and that it’s okay if those tax cuts are saved:

[full-sized version]

Quite a bit more on this here: Households’ Balance Sheets and the Recovery, CBS MoneyWatch.

Check out that CBS Moneywatch link for the full argument.

Four quick charts (click on each to enlarge). One is that I’m very interested in the issue of a balance sheet recession and households are definitely looking like they are repairing their balance sheets for the foreseeable future:

But one thing to keep in mind, especially as we talk about tax cuts as a way of repairing balance sheets, is that there is a big distributional issue here with the balance sheet problem. The problem of working off this massive debt load is concentrated largely among the middle class. It is certainly not a major issue for the top 10% of Americans, and as such tax cuts for the richest 3% of Americans won’t help with this problem for the recovery. (Mark doesn’t suggest this.)

It’s useful to see this problem as a cross-section. From the Federal Reserve’s Changes in U.S. Family Finances from 2004 to 2007: Evidence from the Survey of Consumer Finances:

The first chart is the leverage ratio – debt/assets, by income distribution. From 1998-2007 we see the leverage ratios of the top 10% decline, while the leverage ratios of the 20%-90% range of household income range skyrockets. Notice that the average overall doesn’t change much, but the dynamics underneath involves a lot of shifting around, with the biggest percent gains in the 20-60% of the distribution.

The second chart (click through to see the whole thing) is the ratio of debt payments to family income. We are interested in the first two boxes, which are the aggregate and median for debtors. Once again, same dynamic. From 1998-2007 we see the debt payment ratio of the top 10% decline, while the leverage ratios of the 20%-90% of household income range increases. This also happens with the median value of the top 10% of income; so those at the 95th percentile of income also see a similar decline.

I want to point out this post from the LA Times, The consumer isn’t overleveraged — the middle class is about a BofA Merrill report:

The report hammers home what you might already suspect: The consumer debt problem in the economy really is a debt problem for the middle class. The need to work off a chunk of that debt will sap middle-class families’ spending power for perhaps years to come…

By contrast, the upper 10% of income earners face a much smaller debt burden relative to income and net worth. Those people should have ample spending power to help fuel an economic recovery.

What’s more, on the asset side, BofA Merrill says the middle-class has suffered more than the wealthy from the housing crash because middle-class families tended to rely more on their homes to build savings through rising equity. Also, the wealthy naturally had a much larger and more diverse portfolio of assets — stocks, bonds, etc. — which have mostly bounced back significantly this year.

I think the most sensible way to get through this debt is to have well designed mechanisms for writing down housing debt, where homeowners take a penalty and creditors get an excessively large claim on future housing price appreciation. Lien-stripping (“cramdown”) would have been the smartest way to do this and I hope that it will still be a possibility at some point in the future. Getting aggressive about the valuation of second-lien mortgages on the books of the largest banks would also be a good idea.

But regardless, extending the tax cuts for the richest 3% of American’s won’t help with the balance sheet overhang problem. Good for them but bad for policy options, they simply are doing too well to be hit by these concerns.