Tuesday, November 9, 2010

Deleveraging: Update on Pace and Composition

Yesterday, the New York Fed came out with their second quarterly report on household debt and credit. I discussed the first one here.  The executive summary of this post today is:
  • Deleveraging is continuing at roughly the same pace as before
  • The bulk of deleveraging is occurring due to default and charge-offs, but there is a small amount of it occurring via actually paying down the debt. 
The most important graph from the quarterly report itself is this one:

Because that is nominal dollars, I did the same thing as last time and converted the debt to a percentage of disposable personal income (from the BEA):

The blue line is the data, and the red line is an eyeball extrapolation.  Of course, I'm not saying things will continue in a straight line - it's just an illustration that the general pace currently would, if continued, have us deleveraged back to reasonable levels sometime towards the end of the decade.

To look at the same data another way, here is the prior four-quarter change in the debt-to-DPI ratio:

You can see that there are some tentative signs of stabilization at a rate of about 5 or 6 percentage points per year of deleveraging.

This graph illustrates my fundamental quarrel with Krugmanism.  Look at what happened after the 2000 recession: people almost got to the point of starting to deleverage a bit during the recession and the jobless recovery following, but then as soon as the recovery started to take hold, they began leveraging up even higher again.  In my view, American consumers are only deleveraging now because they have experienced, and are experiencing on an ongoing basis,  economic pain.  If the pain were to have been alleviated by massive government stimulus, the deleveraging would stop.

The fed quarterly report also contains a supplement that begins to address the question of whether all the deleveraging is happening via charge-offs and default, or some of it by actually repaying debt faster than new debt is taken out.  There are two graphs.  The first one shows the change in non-mortgage debt level after removing charge-offs:

As you can see, people have stopped accumulating new debt, and just started to slightly reach a net pay-off position in 2009, of perhaps $15 billion or so.  I estimate from the overall debt balance graph that the total reduction in non-mortgage debt was about $120 billion in 2009 (give or take $10-$20b).  So this suggests that something like 80-85% of non-mortgage deleveraging is occurring via charge-offs.

For the mortgage debts, the graph is this one:

Here the blue line represents the amount of new mortgage balance that occurs because of people selling houses and buying new ones (not via default processes).  The red line represents the net change in mortgage balance because of foreclosures, short-sales, etc.  The green line represents change in mortgage balance because of people just making their payments, thus reducing the principal, as well as change in balance of home equity lines.

So roughly, if we compare the green line and the red line, we can see that about twice as much principal reduction was occurring via charge-offs as via net pay-down of debt (again in 2009).  Thus, as with the non-mortgage debt, mortgage deleveraging is mainly occurring via default, although with a slightly higher fraction of actual repayment occurring.

Of course, even though most deleveraging is occurring via default, it is quite significant that consumers, in some cases at the insistence of their lenders, have at least started to repay on a net basis, rather than continuing to increase their debt balances.


brett said...

What makes the green line positive (from 2000-2008) if it is just people paying down their loans? Refinances?

Gary said...

"In my view, American consumers are only deleveraging now because they have experienced, and are experiencing on an ongoing basis, economic pain. If the pain were to have been alleviated by massive government stimulus, the deleveraging would stop."

I'm not sure this is true. There was a period of very lax lending standards - mostly due to poor regulation of the banking industry. Assuming the banking industry could be brought under control, stimulative spending for the rest of the economy need not pile on more private debt.

Burk said...

Hi, Stuart-

I appreciate your focus on deleveraging. But you have to ask.. what is the point? The point is to have a stable financial system and durable prosperity, not to put working people through the wringer of unemployment to establish an army of reserve/unused labor for the benefit of capitalism/capitalists.

So, were we to take the time machine back ten years, the better tools to address growing debt would have been to restrict debt at its source- to make the Fed and other agencies actually regulate the financial industry, enforce rational lending standards, and bring all its debt instruments under the regulatory umbrella, etc. There are still bankrupt big banks out there, though their corruption of accounting standards hides it.

In Keynesian terms, the Bush tax cuts were good policy- directed to the wrong people, but still important in keeping the private economy afloat in the face of huge leakages in terms of the trade deficit and net saving. Private debt would have otherwise grown quite a bit faster and the debt crisis come sooner. Which is to say, Bush almost got away with it scott-free.

In the end, what is the better way to regulate the private debt level? Through rules that enforce responsible behavior on lenders and outlaw self-dealing in the many forms that brought on this crisis, or through economic recession and punishment of main street? You refer to "pain" as the most virtuous of medicaments, sounding like an original tea partier.

But it would surely be better to have the pain applied when a person can't get a loan by virtue of not qualifying for it, rather than having the pain applied after they get a loan, enter default, go bankrupt, and end up on the street with the house signed over to the bank that was likewise victimized by the originating predatory lender.

I'm with Gary!

rks said...

The other side of Krugmanism is that the pain should come through normal level interest rates. And to get that the net exporters, like China, need to import as well, instead of lending cheap money to the world. I'd love to ask Mr Krugman if he includes the oil exporters in this. Should all that oil flowing out be matched by gold plated Cadillacs and racing camels flowing in? Well at least they're buying Nuclear Power. The other question is: if it worked and we returned to full employment and started driving around a lot, how much oil would we need and what if we can't actually pump that much at the moment? We need to go slowly at the moment, one way or the other, because changing infrastructure takes time. The trouble is that we are changing infrastructure much more slowly than is needed to do the job.

Anonymous said...

"If the pain were to have been alleviated by massive government stimulus, the deleveraging would stop."

I think this is Krugman's point. For all intents and purposes, all money is debt. All money loaned into existence must be repaid in the future, with interest, thus requiring that the future have more money (that is, more debt) than the past. Deleveraging reduces the amount of "money", making it impossible for future debts to be repaid, forcing defaults, making it impossible for future debts to be repaid, wash, rinse, spin, repeat. Krugman, like virtually all economists, is afraid of deflation to his core. Deleveraging is a heavily deflationary activity. The mainstream economic models do not function in a world of decreasing money/debt... and they don't have a plan B so anything they can think of to get plan A going again must be considered good.

James said...

At the risk of being partisan, I think it is worth taking a look at which administrations got the US into its current public debt predicament: