Debt is no longer a four-letter word in the US. So far, the mother of all deleveraging has seen US household debt (ex student loans) falling by no less than 10% or $1.3 trillion since 2008. This decline is even more impressive when measured in inflation-adjusted terms, with real debt outstanding now 15% below their 2008 peak.
And as opposed to popular belief, American households should get more credit for reducing their reliance on credit. While debt write-offs by banks are playing an important role in the ongoing deleveraging process, active deleveraging by households is playing a similarly important role.
So rapid has been the detox process that Americans are now starting to show some early signs of willingness to test the waters and ease some of the accumulated credit pent-up demand. And banks, faced with improving credit quality of their existing poll of potential borrowers, appear to be more willing to supply that demand. The surprise will be how quickly debt will start oiling the rusty domestic US economy—just in time for big fiscal drag of 2013.
What is different about the current episode of deleveraging is that any other period of deleveraging in the post-war era was via increased income (which led to a decline in the debt-to-income ratio). This time around the decline is led by an actual decline in debt, with the relatively slow increase in income limiting the full scope of the deleveraging process.
Zooming in on the actual decline in nominal debt—it is widely believed that we are not really seeing a real change in household behaviour, and that the so called deleveraging is mostly due to write-offs by banks. But a closer look suggests that we are in the midst of a significant historic change in credit utilization by households.
Let’s start with consumer (non-mortgage loans). Note that prior to 2009 US consumers were increasing their non-mortgage debt (excluding defaults) by close to $200 billion a year. In 2009 and in 2010, they stopped borrowing altogether—suggesting an annual decline of $200 billion in their purchasing power. Note that while the headline number is still showing a modest decline in credit growth in 2011, the active borrowing (net write-offs) is now up by $90 billion, signifying increased willingness/ability to borrow.
Turning to mortgage debt. There are three ways in which mortgage balances can change:
Transactions—originations of new mortgage plus normal payoffs
Active—amortizations, refinance and balance change
Our focus here is on the active part. The cumulative amount of the active reduction in debt between 2008 and 2011 was just under $700 billion, this is a pure active deleveraging that is hugely ignored/misunderstood in the current discussion regarding deleveraging.
Now, what is behind the active deleveraging? Demand (households payoff their debt voluntarily) or supply (banks not providing credit)? The answer is probably both. Note that between 2008 and mid-2011, we have seen a significant decline in the number of credit enquiries—a pure demand factor. Note that this number has started to rise lately. But it seems that supply played an even more important role. Faced with surging defaultrates, banks limited credit availability at a rate and scope not seen in the post-war era. But lately, with default rates on consumer credit back to normal and average credit score of indebted households at a record high (the write-offs are helping here), banks’ willingness to lend as measured by the percentage of banks willing to extend credit is improving notably.
By Benjamin Tal, CIBC Economist