The team has lost its old vigor. Given every encouragement by trainer Greenbucks, cheerleader O'Denial, and team manager Loosepockets Shrub, it still doesn't impress like it used to. It's handicapped in some way. Wait! Perhaps that's it. Aren't those players carrying a bit of extra weight? They're muscular, of course, pumped up by all the weight training, so it's hard to tell, but don't they look sluggish?
The burden of debt. It weighs on you. Is it weighing on the world's biggest economy, the economy that used to win with the regularity of the New York Yankees but that now is tending to disappoint?
The American Bankruptcy Institute finds the number of bankruptcies is rising. 2001 was the worst ever year for bankruptcies, but they have been running at a very high level since 1997. Why? The vast majority of these bankruptcies -- 391,000 of the 401,000 in the second quarter of 2002 -- are "non-business," that is, of households. And the consumer is more indebted and therefore more exposed, even when the economy was doing well and unemployment was running at a low level in the late 1990s. "Household debt is at a record high relative to disposable income," the ABI writes on its website. Since 1993 the level of household debt relative to household income has been rising steadily, from less than 12 percent of income to over 14 percent.
Perhaps all this is unsurprising. After a decade of growth the economy has been weak now for almost two years. Of course some companies and individuals have been caught out by the slowdown. But is there also a more generalized and troubling problem, a vulnerability created by a decade of fast growth and free lending, a problem that is only just beginning to show itself?
This is a question some are asking. Francois Velde, a senior economist at the Chicago Federal Reserve bank took a long view at the question of household debt in a paper published this month.
Velde found that debt, like baseball players and the general population, have been getting bigger for a long time. While, over the past 50 years, U.S. household assets have remained very close to a level of 4 to 5 times Gross Domestic Product, household liabilities (though still much smaller) have trebled, rising from 24 percent to 78 percent of GDP. One therefore cannot tell much from rising debt statistics, Velde writes, because household debt "reaches record levels every other quarter on average."
Velde applauds the secular trend. "Debt is good," his paper says. He argues that debt permits younger households to buy property when they need to. They can set up home on the basis of the future income they will enjoy. Debt also permits families to "better plan their consumption and smooth it over time."
Seen in this way, rising debt is one of the many benefits Americans enjoy as a result of their deep, super-competitive and excellent financial markets. The willingness of lenders to lend is itself a sign of an advanced and successful civilization. It requires trust to make large sums of money available to another person, even if the loan is secured by property, as in the case of mortgages. American financial institutions have this trust in spades. They compete to lend. The legal framework is there to permit them to reclaim the asset on which they have lent money. All this Americans take for granted. Yet nowhere else in the world does the capital market work so well. Try borrowing money in Mexico or Tunisia.
It is mortgages that make up the bulk of household debt. As of the first quarter of 2002, 67 per cent of household liabilities were mortgages and another 21 percent consumer credit. In the past five years Velde finds that "as house values have increased, so has mortgage debt in the same proportion."
Velde does not ask however, what happens if house prices fall? The question is pertinent because house prices in the United States have continued to rise rapidly even in the past two years of economic slowdown, fed by the low interest rates that have sought, so far unsuccessfully, to get the economy running fast again.
If house prices fall, the mortgage debt remains as a burden on households but the asset backing them is less valuable. A homeowner who sells his home may find he is obliged to take out a loan in order to repay his mortgage. In the case of repossession, meanwhile, the lender finds himself suffering a loss if the house is no longer worth as much as the loan made on it. These are dangers.
Velde goes on to consider how other falling asset prices, the prices of U.S. stocks, have affected household assets and household consumption. The wealth effect -- the impetus to spend more because the rising value of assets makes you feel better off --is widely believed to have been a phenomenon of the late 1990s: U.S. consumers consumed more because their rising share portfolios and the rising value of their property made them feel wealthy.
But Velde, again taking the long view, argues that "recent years have shown consumption to be abnormally low given the long-run historical relation between consumption and wealth."
We might suggest a reason for this: stock assets rose in value so fast in the 1990s -- from an average of 18 percent of household assets to 36 percent of those assets in 1999 -- that the level of spending could hardly have been expected to keep up with them. And it is fortunate that it did not, for U.S. consumption growth in the late 1990s was already high and has remained robust since, a phenomenon that is reflected in the record high trade deficit.
Velde, however, draws sanguine conclusions. The team is not in such bad shape after all. "Neither the assets side nor the liabilities side of household balance sheets seems grossly out of line with the past."
As we have suggested here and there in our comments, this is not a conclusion with which we would tend to agree.
Velde does acknowledge however that the rise of household debt in relation to household income may pose a problem. In our view, it is hard to see how it can avoid doing so. Households have more debt; interest rates are very low; unemployment is tending to rise. If the U.S. economy does recover, interest rates will certainly be raised and debt that has not been taken out at fixed rates will create a greater interest burden for many households.
Compounding this problem is that if interest rates rise, house prices are likely to come under pressure. Household debt and household assets may no longer move in the neat parallel Velde has observed during the housing boom of the past five years.
If, on the other hand, the U.S. economy does not recover strongly, then rising unemployment and depressed incomes will also increase the ratio between debt and the capacity to pay it.
Is debt another obstacle to healthy recovery of the U.S. economy? We would say it is. American households (and companies) have borrowed too freely, reassured first by rising stocks and a fast-growing economy, and more recently by rising house prices and low interest rates.
The team over-indulged on things in the successful times, and debt was one of those things. It will be hard to work off that added burden. Success won't come again until it has been done.
(Global View is a weekly column in which our economics correspondent reflects on issues of importance for the global economy. Comments to [email protected].)
