Was the dramatic deleveraging of
American households during the financial crisis solely the result of charge
offs and defaults or were there other factors at play? The Federal Reserve of New York recently
looked at trends in consumer debt before and after the Great Recession.
Financial Crisis at the Kitchen
Table: Trends in Household Debt and
written by Meta Brown, Andrew Haughwout, Donghoon Lee, and Wilbert van der
Klaauw and published in Current Issues in
Economics and Finance, is based on data from the Feds Consumer Credit Panel
which represents a 5 percent random sample of U.S. individuals and members of
their household with credit files - in total about 15 percent of the
population. The study used information
from the credit reports of these individuals for each quarter over the last
thirteen years, up to September 2012.
The Federal Reserve System's Flow of
Funds Accounts show there was a steep run-up in consumer debt starting in
1999. On March 31 of that year consumers
owed about $4.6 trillion to creditors but over the next nine years that rose
more than 170 percent, reaching $12.7 trillion at the end of the third quarter
of 2008. Driving this growth was an
increase in residential real estate debt which almost always accounts for 70
percent of household liabilities.
Amounts owned on installment mortgages and home equity lines of credit
(HELOCs) tripled over this period, from $3.3 trillion to $10 trillion. At the same time other types of consumer debt
nearly doubled, going from $1.4 trillion to $2.7 trillion.
The study found many factors accounted
for this increase including rising populations, rising incomes and stock
prices, rising house prices, falling interest rates, and the "democratization"
of credit. During this period assets
were growing as well so consumers' net wealth grew steadily over the period.
Delinquencies remained stable during the
1999 to 2006 period at about 4 percent of outstanding debt 30 or more days past
due and 2 percent over 90 days delinquent.
Then rates rose quickly during 2007 and 2008 reaching a peak of 30+ day
rate of 6.7 percent at the peak of debt in Q3 2008.
Since then U.S. consumers have reduced
their debt, according to data from the Panel from an aggregate of $12.7
trillion to $11.3 trillion or a decrease of $1.4 trillion by the end of Q3
2012. Total debt has decreased roughly
11 percent from the peak with mortgage related debt now accounting for 76
percent; the remainder is comprised of credit cards, auto loans, student loans,
and other consumer debt. The Flow of
Funds Accounts reflect a slightly lower decline in debt, slightly more than
$960 billion, but both sources indicate steep declines in 2009.
Even after debt peaked delinquencies
continued to climb, reaching a maximum level of 11.9 percent in the fourth
quarter of 2009 (severe delinquency peaked in Q1 2010 at 8.7 percent). Both measures of delinquency declined
decisively from their peaks to 8.9 percent and 6.6 percent respectively in the
third quarter of 2012, the most recent date of available data.
The "flow into delinquency" measures
debt balances that were previously current but became delinquent in each
quarter. Debt performance deteriorated
across all debt types but it started with installment mortgage debt (excluding
HELOCS). Between Q4 2005 and Q4 2008 new
installment mortgage delinquencies tripled from $98 billion to more the $310
billion then slowed steadily. New
mortgage delinquencies reached a recent low of $140 billion in Q3 2012.
At least three major mechanisms account
for the recent decline in consumer debt:
consumer use of and demand for credit;
lender supply of credit;
increasing amount of nonperforming debt written off by lenders.
If charge-offs explain the entire
reduction in debt there is little need to understand the role played by the
other two, but when charge-offs are stripped out of non-mortgage debt and that
debt is broken into two parts - student loans and all other loans - the study
found that up to 2009 consumers were increasing both of these nonmortgage debt types
each year. In 2009 and 2010 the "other"
component became negative ($68 billion and $15 billion respectively) but
student debt continued to grow.
Accounting for mortgage debt is more
complicated because after a charge-off and foreclosure there is a house to be resold
to another party who may take on a mortgage thus reducing the net debt
reduction from the charge-off. This
prevented the study's authors from allocating mortgage debt decline to net
charge-offs or changes in active borrowing and repayment. Instead they focused on behavior by dividing
the change in mortgage balances into three components:
related to housing transactions (payoffs, new mortgages). This component fell sharply as the value of
housing transactions declined. In this
component the authors excluded the effects of charge-offs.
contributions of charge-offs. Here is
clear evidence of the foreclosure crisis with charge-offs totaling around $1.3
trillion from 2007 through 2011.
refinances of first liens, changes in junior-lien balances, and regular
amortization of first lien balances.
While amortization reduces balances at a
fairly steady pace, the other components have declined sharply since 2007. This is interpreted as indicative of consumer
responses to economic and financial conditions.
From 2000 to 2007 they extracted equity and increased mortgage debt by
an average of $135 billion per year; in 2008 this component turned negative and
reached -$214 billion in 2011.
Taken together the information on
mortgage and nonmortgage debt indicate major changes in consumer behavior other
than delinquency and default. Borrowing
contributed an annual average of about $350 billion to consumers' cash flows
between 2000 and 2007, by 2010 consumers reduced their cash flows by $138
billion to reduce the debt, a net change of -$500 billion in just three years.
The remaining issue is whether this debt
reduction was voluntary or if consumers were forced to pay down debt as credit
standards tightened. The study found the
was a substantial decrease in the number of open credit accounts, especially
credit cards after the 2008 peak. Credit
card accounts dropped by 120 million between Q2 2008 and Q3 2010.
number of installment and revolving credit accounts opened was high and flat during the middle of the
2000 decade but then began a decline in early 2008 that extended through Q3
2010, falling by 40 percent to 158 million.
Since then account openings have increased modestly to 177 million, well
below the peak.
determine if the decline in new accounts was attributable to tighter lending
standards or lower consumer demand the authors looked at account inquiries and
found significant declines, concluding that fewer applications for credit
contributed to the decline in account openings.
closings have rising since 1999 although not steadily. From third quarter 2008 to third quarter 2009
they underwent a sudden, steep increase from 226 to a peak of 376 million then
moderated to 185 million. So at a time
when new account openings were down, accounts were being closed in record
numbers, however it is unclear whether borrowers or creditors were closing
these accounts. There is separate information
that large banks closed large number of accounts in 2009, particularly inactive
or troubled ones.
were steep decreases in borrowing limits on credit card accounts (almost
entirely lender driven) while at the same time utilization of HELOC balances
increased by 5 percentage points.
The authors conclude that the decline in
consumer debt is temporally correlated with the very rapid rise in unemployment
rates in the second half of 2008.
Households may choose to build their precautionary savings or increase
their available credit to insure cash flows against job loss. This action would tend to reduce debt balances
outstanding. Households may also use
credit accounts to smooth their consumption, leading to more borrowing. While both types of behavior were present,
the overall decrease in debt would suggest the precautionary behavior
From the asset side of the balance
sheet, an important consequence of the initial increase and then drop in home
prices is the dramatic fall in home equity.
Given that the recent decline in housing prices is unprecedented in
recent years there is little evidence of the effect of such large declines in
housing wealth on the demand for debt.
However, if a large decline in net worth can, in fact be expected to
increase the marginal value of net savings, then this drop in equity may have induced
net savings via reduction of mortgage debt along with other methods.
The question remains whether, in light
of recent improvements in credit availability, how much further voluntary debt
reduction will go before consumers begin to spend again. While debt pay-down has helped improve household
balance sheets it has likely also contributed to slow consumption growth since
the beginning of the recession. Thus the
trajectory of debt has important implications for economic growth going