Looking under the hood of U.S. household debt

Although the Great Recession is over, Americans remain in debt, whether it is housing debt, student loans, or auto loans. Is it too soon to say that the economy has recovered from the 2008 crisis? And what can be done to prevent another Great Recession?

Coming out of the 2008 financial crisis, a main narrative was that in the search for ever higher returns in mortgage markets, investment bankers made risky bets. These bets went sour, toppling mammoth financial institutions, wreaking havoc on credit markets, and tanking the world’s economy in the process. What made the Great Recession “great”? The answer seems to lie in the significant levels of debt that U.S. households had accumulated the decade before. Although the economy has since returned to something resembling normalcy — with unemployment at 3.8 percent and GDP growth averaging near three percent, debt accumulation is reemerging without much hand-wringing or flag-raising. Are we doomed to repeat history?

Perhaps, or maybe, perhaps not. It’s complicated. To understand this complexity, one must examine the mechanics of U.S. household debt and what implications those levels of debt have on household economic behavior and consumption.

How does the current economy compare to 2008?

Economists generally agree that the levels of debt U.S. households accumulated prior to the financial crisis both deepened and prolonged the downturn. Moreover, many concede that in the immediate aftermath of the recession, U.S. households changed their consumption patterns to prioritize debt repayment over consumption, which in turn decreased U.S. GDP growth. Although the prioritization trend reversed in early 2013, the United States is still approaching overall debt levels similar to 2008 levels. Another potentially troubling factor is that U.S. households continue to save little compared to other OECD countries. In 2015, the OECD calculated that United States had a savings rate of 4.1 percent of GDP, which put the nation behind 25 out of 39 measured countries, and fell far lower than China’s 46.9 percent savings rate.

A look into U.S. household data reveals a nuanced picture that helps explains why debt is such a cornerstone of Americans’ spending habits. A growing diversity of debt obligations, such as house, car, credit card, and education payments, creates major challenges for specific sub-populations, and especially for minority households. Although debt-to-income ratios do not appear outside the norm, household debt could cause wide swaths of undue harm by limiting access to other credit markets, thus further dividing American society by age and socio-economic status and contributing to increasing levels of inequality.

To put debt crisis in context, let’s take a step back to compare U.S. households to the rest of the world. The IMF found that, in 2016, the U.S. household debt to GDP ratio was 76.66, equating to over 13 trillion dollars in outstanding debt. This ratio is higher than many countries, but still below other developed countries such as Switzerland, with a ratio of 126.32, and Sweden, with a ratio of 85.06. Should we be worried about this level? That depends. Although economists generally agree that there is a “tipping point” where there is “too much” debt, not all agree on what that level is. That said, most analysts believe that the United States has not reached its tipping point.

What accounts for US household debt?

The Federal Reserve of New York categorized U.S. household debt into just two categories, housing and everything else. There is good reason: mortgage loans are by far the largest contributing factor to overall U.S. household debt. The New York Federal Reserve attributes $9.56 trillion out of $13.51 trillion, or 70.76 percent, in total U.S. household debt to housing related liabilities. Notably, 70.76 percent is slightly below the level during the 2008 financial crisis, which peaked at almost $10 trillion in housing debt in Q3 of 2008. More importantly, housing debt delinquencies are also at historical lows, at 3.24 percent, indicating that more borrowers are financially stable and able to make their payments.

What about non-household debt?

On the other side of the ledger is non-housing debt, which consists of all other debt including credit card, auto, and student loans. The New York Federal Reserve has calculated non-housing debt in Q3 of 2008 and 2018:

Notably, while student debt and auto loans have both increased, credit card debt has stayed relatively constant over the past decade.

If housing-specific debt is not a cause for concern due to low delinquency rates, then is non-housing debt of concern? While economists disagree over the levels of harm of non-housing debt, debt is generally considered more harmful if it restrains individuals or if delinquency rates grow or spike.

After mortgage debt, student loan debt comprises the second largest category of outstanding debt, with a total of $1.4 trillion. Over the past decade, student loan debt has almost doubled in size, carrying with it a delinquency rate of 11.5 percent. Student loans represent the highest level of delinquency rates today, higher than mortgage delinquency (8.9 percent during the 2008 crisis) and almost as high as credit card delinquency (13.7 percent in 2008). These numbers raise red flags. There are approximately 44 million student loan borrowers, with the largest concentration between 30 and 39 and accounting for $461 billion, or 32%, of total student loans. This indicates that the youngest cohort of working-age Americans are holding the most student debt.

Some prominent Democratic presidential candidates, such as Bernie Sanders, Kamala Harris, and Elizabeth Warren have stated that student loans present a major limiting factor for younger Americans. They have cited real world consequences of these loans, including difficulties in purchasing homes and delayed marriage trends.

Some policymakers have even called for total student debt forgiveness, and although complete forgiveness has not been implemented at either the federal or state level, the Obama administration has enacted federal loan forgiveness and income-based repayment programs to help students pay back their loans as a means to try and tackle the issue.

Car financing has driven the debt delinquency rate to approximately 13 percent, which is a level not seen since 2008. The Kansas City Fed makes the case that this delinquency trend is primarily explained by subprime loan borrowers. However, it downplays the threat that these delinquencies pose to the larger economy, since subprime borrowers only account for approximately 25% of all auto loan recipients.

Credit cards also contribute to U.S. household debt — but primarily the revolving debt burden, and not overall debt. NerdWallet notes that credit card balances carried over from month to month reached $420 billion in 2018, a five percent increase from 2017. Importantly, this revolving debt usually carries high interest rates – averaging 16.71 percent, according to USA Today.

Conclusion

U.S. households continue to accumulate significant amounts of debt, with corresponding impacts on consumption, wealth creation, employment, or potentially a household’s risk averseness. These impacts have drastic and far ranging consequences for the U.S. economy, as well as household decision-making. Ten years beyond the financial crisis, it doesn’t look like the United States is out of the woods.

Photo credit: Arliss, Flickr

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