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Record Household Debt: The Counter-Argument

The lead topic in Tuesday’s Forecasts & Trends E-Letter was the fact that US household debt hit a record $12.73 trillion in the first three months of 2017. That figure was $149 billion higher than at the end of the 4Q of last year, and $50 billion above the previous peak in 2008 according to the latest New York Federal Reserve Bank report.

Yet the report was not all bad news, as I pointed out. Debt balances on home equity lines of credit fell slightly in the 1Q, and credit card balances were actually down by 1.9%. I also pointed out that the new high in household debt means that many Americans have rebuilt their credit and are once again able to borrow money – which could be good for the economy.

I also pointed out, however, that the new record high in household debt could keep Americans from buying houses and other large purchases that spur economic growth — and possibly trigger another round of defaults, as happened in 2008.

A number of financial writers have made the case that the new record in household debt is meaningless and therefore, nothing to be the least bit concerned about. While I disagree, I will summarize this argument briefly below.

The most cited issue among the “no problem” crowd is the fact that the Fed’s $12.73 trillion debt number was not adjusted for inflation or population size. They argue that the $12.73 trillion in debt is held by more Americans than at the previous peak in 2008. That is true but it’s still $12.73 trillion versus $11.24 trillion at the end of last year (which was also held by more people than in 2008).

HOUSEHOLD DEBT EXCEEDS 2008 LEVEL


Source: Federal Reserve Bank of New York; USA Today

Their next argument is that US households, on average, are in considerably better financial shape today than they were in 2008 at the brink of the financial crisis. They admit that mortgage loans still comprise the majority of household debt, but they represent a lower share of the total debt.

Yet this is largely because auto loans and student loans have exploded since 2007. Both auto loans and student loans are considered higher risk loans because cars and trucks depreciate very rapidly, and you can’t foreclose on a college diploma (no collateral).  The same can be said for most credit card debt since the assets purchased often lose most of their value or disappear.

Student loans, now at a record $1.3 trillion, have by far the highest delinquency rate of any of the major categories of debt. The delinquency rate has been hovering at around 11% since 2013. Yet student loans have increased every year in the past 18 years since the Fed began tracking it.


Source: Federal Reserve; Equifax

The no-problem crowd also points to other facts from the latest NY Fed report showing that as a share of the US economy, household debt is smaller today than 2008 levels. Household debt is equivalent to 67% of the economy in 1Q 2017, compared to 85% in 2008. While that may be encouraging, it’s still $12.73 trillion, the highest level in our nation’s history and climbing.

There is one statistic pointed out by the no problem crowd which is very encouraging — but not necessarily for the reasons they cite. The Fed also reported that household debt service payments as a percent of disposable income have fallen significantly since late 2007.


Source: Federal Reserve; Mother Jones

The significant decrease in this ratio is not primarily because households are making a lot more money, and not because the economy has been booming. Rather, it’s because interest rates fell dramatically during this period thus lowering payments. Debt service as a percent of disposable income is at the lowest level in 40 years, and has held essentially steady for over four years.

In summary, it is true that household debt in relation to median income is not as high as it was in 2008. It is also true that the $12.73 trillion in household debt reported by the Fed last week was not adjusted to reflect inflation or population growth. Yet it is still more household debt than ever before, and rising, even if it is owed by more Americans than in 2008.

Finally, the record level of household debt is of lower quality today because student loans and credit card debt have exploded in the last decade, yet neither is legitimately backed by collateral.

I would also argue that 60 to 72-month auto loans are lower quality debt today. Although auto loans are collateralized, we have to consider how fast cars and trucks depreciate, and how many Americans are “upside-down” on their car loans.

I rest my case.

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