On Debt Deleveraging: How Much More to Go?

by: Alicia Damley, CFA

Last week, the Federal Reserve Board (FRB) released its updated Flow of Funds data series, which tracks US debt. The current release of the Z.1 time series goes back to 1976 and provides quarterly figures since 2004 (see here).

The most recent financial crisis, fed by excessive debt accumulation, is now in the de-leveraging phase. The Federal Reserve is now the de-facto lender to many debt market segments, while other parts of the sector stabilize their balance sheets and funding. Debt outstanding, particularly for the financial and mortgage sectors, has grown dramatically since the mid-1990s.


In absolute terms, mortgage debt of $10.1 trillion is now second in size only to the domestic financial sector and federal government debt has eclipsed corporate debt. Over the period covered, total debt outstanding has grown on average by ~8% annually. While year-over-year growth through the late 1980s was consistently in the low teens, it has since declined to the high single digits.

Looking specifically at mortgages, recent growth is actually not the highest in the period covered, but the duration of above average growth has been longer. In the crisis fallout, growth has gone negative, significantly below the 5% floor of the mid 1990s, fueled by the mistaken belief that neither house prices fall nor debt o/s compress. Federal government debt has stepped in to fill the gap.

As seen previously, domestic financial debt has grown strongly, expanding from 10% of total system debt to 30% by 2009. Excluding financial sector debt, in 1976, mortgages accounted for one fifth and total household one third of the system debt. By 2009, mortgages had grown to 31% of debt outstanding. Given its recent rapid growth, federal debt currently accounts for 23%.

A key question is how much longer is the de-leveraging likely to continue? At the end of 2009, mortgages accounted for 30% of total debt outstanding, down from a 2006 peak of 34% ($13.8 trillion). Pre-crisis data suggest a trend share of ~28%, implying another $600+ billion in additional reduction.

An absorption of this magnitude would likely require a number of participants, including government assisted mortgage write-down relief, MBS or other mortgage securities losses and/or bank write-downs. For reference, as of Aug 2010, the US commercial bank sector had $1.4 trillion in net assets and depository institutions had reserves of $1.1 trillion at the FRB.

Household debt is in its third year of steady decline. Since 2007, mortgages outstanding have declined by $412 billion. By one set of metrics, the system is getting there.

Disclosure: No positions