21 Aug Household Debt Is Back. Should We Be Worried?
Every four months the Federal Reserve Bank of St. Louis releases information on income and debt for households across the country. Their most recent release represented a significant event as total household debt exceeded the prior peak which was set right before (and arguably caused) the financial crisis in 2008. The mainstream press has latched onto this single figure to conclude that a recession is imminent! If it happened before it must happen again, right? With a little more research we can see why today’s circumstances are significantly different than 10 years ago.
The chart above shows the relationship between debt and income over the past ten years. The total amount of debt owed by households peaked in early 2008 and fell dramatically during the crisis. Debt outstanding hit a low in 2010 and has steadily been rising ever since. Very simply this makes sense. Household balance sheets were destroyed during the crisis but over time households found firm footing and began building for the future again. This reset allowed consumers to look to the future with optimism rather than abject fear which in turn encouraged households to slowly cautiously borrow again.
This ability to set aside fear and begin to build for the future was fueled by improving household balance sheets. Along with having less debt, incomes have slowly risen over the past ten years. This combined with lower debt levels (and the associated payments) has pushed up the amount of disposable income that households have. In 2008, outstanding debts exceeded total disposable income in the country! Looking back we were ignoring grandma’s financial advice: don’t spend more than you make. At least temporarily we seem to be taking that age old wisdom to heart.
The wide gap between household income and debt levels provides a buffer to households across the United States. Because we as a society have more money to spend that is not tied up in servicing our debt we are better able to absorb a drop in income and continue to live our lives. While there are plenty of other reasons a recession may appear this simple analysis suggests that debt levels are unlikely to be the catalyst for such an event.