Unprecedented Household Deleveraging since 2007
By Robert Higgs • Thursday December 20, 2012 1:36 PM PDT • 3 Comments
For decades, American families espoused the not-quite-Cartesian ontology: I go into debt; therefore I am. Household debt climbed ever higher through good times and bad. Since the onset of the current recession, however, household debt has contracted substantially for the first time in more than half a century.
After reaching a peak at $13.82 trillion in the first quarter of 2008, household debt outstanding fell to $12.87 trillion in the third quarter of 2012, down by about $1.0 trillion, or almost 7 percent.
During the past year, the rate of decline has slowed considerably, so the outstanding debt may be converging on a minimum. But should the economy’s sputtering recovery falter even further or a new downturn occur, households appear primed to continue their deleveraging.
The unprecedented decline in household debt outstanding during the past five years joins many other variables in attesting that the economic expansion between 2002 and 2007 consisted in large part of an artificial boom—a credit bubble—fueled by the Fed’s easy-money policies, which spilled from the mortgage-financed housing bubble and the stock-market run-up, to rising commodity markets and bloated housing-related sectors, and ultimately to the entire economy’s unsustainable expansion.
The sloughing off of household debt in recent years also signals, for the first time since World War II, a change in people’s long-term outlook. As long as people had faith in the continuation of economic progress in the long term, they did not hasten to pay down debts when recessions occurred. This time, however, they seem to have lost their faith in the economy’s long-term performance. This change at the household level goes hand in hand with the regime uncertainty that has brought about extraordinary reluctance to make long-term investments among investors and entrepreneurs.
It is a common failing for pundits and others to overreact to short-term economic changes, mistaking them for watersheds that alter the character of the economy’s long-run dynamics. The evidence in regard to the household deleveraging and the still-depressed net private investment in recent years, however, may be seen as consistent with an interpretation that the post-2007 economy may indeed have changed in a more fundamental way. If so, we may rightly trace its enduring sickness to the extraordinary government and Federal Reserve actions of the past five years. In the immortal words of Leonard Cohen’s song “Everybody Knows”:
Everybody knows that the boat is leaking
Everybody knows that the captain lied
The policy makers, sad to say, appear to have operated in this period according to the rule, no economic event is so bad that we can’t make it worse if we try hard enough.
Tags: Economics, Federal Reserve, Housing 
One of the main reasons that household debt has increased by such a large amount over the last 25 years or so is because high taxes and inflation on 2 earner families have left these families no choice but to go into debt to make ends meet. Added to the fact that banking institutions,by and large,discourage saving by offering very low interest rates. Many people have maxed out their credit including second mortgages on their homes. In essence they have no choice but to pay down their debts. Of course if you observe how our money system works,the banking system can create more money by putting people in debt. The problem is that many banks aren’t lending but are earning interest on their TARP funds. In essence the Federal Reserve’s tactic of propping up failed banks only works to artificially expand banker’s spread sheets making it appear that these banks are solvent. Of course nothing could be further from the truth. That is why they are called zombie banks. What is happening is the end result of the creation of the Federal Reserve counterfeit money mill 100 years ago. Another Fed created bubble that went bust. Its time to end the Fed before our monetary system totally collapses.
libertarian jerry | Dec 20, 2012 | Reply
Credit market debt has indeed dropped, and I know a lot of my friends who have made a conscious decision to reverse their debt situation and change their lifestyle accordingly.
However, outstanding student loan debt from 1Q 2008 has nearly doubled (from $0.6 trillion to over $1 trillion), and we all know that many of these loans are underwritten by private banks. Given that most of these loans are for 10 years, one could argue that after having completed at least a 4 year degree (if not more), then the reality of possible default on the average $23,300 loan becomes more significant and ominous than the average $5,000 credit card debt, though the “investment” in purchasing an education may have happened years before whatever retail credit debt was rung up. There is, theoretically, an inherent lag in student loan debt relative to when the loan was initiated. Might we see a similar decline in student loan debt over the next 5 or 10 years, as students increasingly realize how much of a rip-off most college degrees have become?
In other words, the student loan bubble-pop could have even bigger implications than retail credit or mortgage debt.
Dom | Dec 20, 2012 | Reply