Are Debt Levels Too High, Or Are Consumers Simply Not Feeling Rich?

by: Steven Hansen

Many pundits are stating debt levels are too high for consumers, even though they have fallen significantly since the Great Recession.

Household debt is mostly mortgages - and should one even consider this debt?

The inflows into consumer debt are at historically normal levels.

Is personal debt restraining economic expansion? Many pundits talk about the debt unwinding cycle not being complete from the Great Recession. Is there some magic formula for deciding if debt levels are too high and need unwinding? Is there historical data which supports a certain debt level being optimum? Total household debt is shown as over 120% of GDP which seems like a large number (and is larger than several advanced economies).

Consider that the size of USA household debt is within the range of the Eurozone countries.

Consumer or household debt is an important topic for the USA economy as it is much more consumer driven than Asia or Europe.

From the mid-1960s to the Great Recession, the consumers share of the USA economy increased. Since the end of the Great Recession, consumers portion of the economy has remained in a tight range. To put framework on the discussion of debt - debt is described in various terms:

  • total household debt
  • mortgage debt
  • consumer debt (total household debt less mortgage debt)

Because of very low interest rates, repayments of existing loans are taking a smaller and smaller portion of household income - and near historical lows.

Consumer debt, even though requiring a historically small portion of income to service (re-pay), is now growing.

Graphically most pundits toss out the total household debt graphs to "prove" there is a debt problem.

However, there is a difference between mortgage debt and consumer debt - and the way one views these "debts" should be different. Mortgage debt is on an asset which generally does not depreciate in value (exceptions are the two depressions - the years leading up to and including Great Depression and the Great Recession). Further, mortgage debt is long term and generally proximates the household spending one would have if one rented rather than purchased their primary residence. Although mortgages are considered debt, they could be described as a long term lease obligation where at the end of the day you own your home.

Consumer debt (car loans, credit cards, and student loans) is on products and services which have no secured value after a period of time. A way to look at consumer debt (instead of looking at total debt outstanding) is to look at monetary flows into new consumer debt - which currently appear to be at the average level which has been seen since the 1970s.

Mortgage debt levels continue to fall because of foreclosures and refinancing of existing loans. The graph below shows the ratio between mortgage debt and income which is currently 1.06 (or saying it another way, total mortgage debt is 106% of yearly disposable personal income).

The USA is spending less than 20% of household income on mortgages - and is the lowest of any advanced economy. Mortgages are approximately 85% of total household debt. This debt is long term and on a real asset that (usually) relatively holds its value - and is roughly equal to household spending on renting a residence. Households are spending a historically small portion of income on mortgage repayments. Therefore, one should not consider mortgage obligations if you were trying to establish whether the consumer was carrying too much debt.

Consumer debt (total debt less mortgages) - seems to be within "historical" boundaries. There is little evidence that "high" consumer debt levels could be restraining economic growth. Yet, consumption is lagging - and so is savings. Something (or some things) may be constraining consumer growth.

It could be that the USA economic gearing is constraining consumer growth. Maybe 67% of the economy is near the maximum support consumers can provide. However, the more likely cause is the changing income distribution occurring in recent decades that has produced nearly a 10% decline in real median household income since 1999.

The most likely reason the consumer is not adding more to GDP is that they have become poorer. However, all is not bad for a portion of the retail sector:

As an investor, this appears to be the growth sector.

My usual weekly wrap is in my instablog.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.