Housing crises tend to create debt crises. And debt crises are generally far more damaging than recessions caused by bloated asset values.
I took a quick trip through FRED and Wikipedia only to be shocked at what I found.
We’re Broke, But It Sure is Cheap
Allow me to introduce you to this chart, the percentage of disposable income used to service the debt of an American household:
You’ll notice that consumers seem to be doing very well when it comes to paying their debts. We are very capable of making our monthly obligations. This is why the default rate on credit cards and auto loans is now at a multi-year low. In fact, credit card delinquencies are coming in a sloth-like pace we haven’t seen since 2001, while only 1/300 people are late on their car payments. Impressive, huh?
Most impressively, the debt service costs of the average American continue to drop while the amount of debt consumers finance has only gone up. Observe the change in this chart, a chart of the total amount of household debt relative to disposable income.
Notice that in 1980 Americans had debt equal to roughly 70% of their disposable income and debt service payments equal to 11% of their income. In 2012, we spend 11% of our disposable income to finance debt worth as much as 110% of our disposable income. Basically, $11 of debt demands as much from the American consumer budget as $7 of debt did in 1980, adjusting for changes in income.
Are the Boom Years Coming Back?
Much has been made of a falling debt service ratio. Economists believe that a falling ratio will allow for economic expansion in that borrowers are capable of carrying more debt now than they were before the collapse.
I think this is half true. I think consumers are in a position where they can afford to borrow to spend. That’s good, I suppose, from the perspective of economic growth.
However, it doesn’t address a critical problem – where will consumers find the money to borrow and spend? That’s the real issue.
I want to introduce you to another chart of mortgage equity extraction, or the amount of money that households pulled out of home equity with financed dollars. Here’s a chart:
Not pretty. As we know, real estate fueled much of the consumption boom from 2002-2006. In fact, it is believed that 75% of all GDP growth during that period was financed by home equity. Basically, without the real estate boom, the economy would have grown at one-fourth the pace it did from 2002-2006. It would not have grown. It would have just stagnated, kind of like the economy is stagnating right now.
This is an important realization. It reminds us that the American economy will go nowhere without housing. Housing is a major source of financial leverage for American balance sheets. Take a look at just how much we inflated our “incomes” with home equity during the boom years:
This is why I think we’re still only halfway through our lost decade. While homeowners are deleveraging, building in room in their budgets for debt, they will not be capable of borrowing for major purchases. Homeowners will not be capable of buying homes, or extracting home equity. Borrowers are capable of financing TVs, cars, or washing machines, but these are relatively unimportant when we talk about the grand scheme of things.
We still have a long way to go. Yes, interest rates are low. And yes, we are spending significantly less on debt than we have in years gone by. But we are not in a position where we can add significantly more to our personal balance sheets.
A credit card here and there and a car loan (secured!) just might fit, but a home equity loan – the source of most American liquidity – is still out of the picture.