Consumer Deleveraging

Forced or voluntary?

March 28, 2011

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1215579_saleOn the more financial pessimistic blogs, the anecdotes lean heavily towards a U.S. economic recovery that isn’t in any particular hurry. Financial Armageddon, for example, offers some grim press clippings on “the mythical recovery.”

At the heart of the recovery is consumer spending, since it accounts for two-thirds of the U.S. economy. There is clear evidence that corporations have rebuilt their balance sheets and could make new investments, but as with the chicken and the egg, why spend if there’s no evidence of pent-up demand.

Which leads to another question: is it that consumers can’t or won’t spend?

In truth, the evidence is mixed. Meta Brown, Andrew Haughwout, Donghoon Lee and Wilbert van der Klaauw, researchers at the New York Federal Reserve, cite two trends U.S. consumers have shed $1 trillion in non-mortgage debt. On the other hand, write-offs of consumer debt are up sharply. Which leads to the question they pose in a paper: “Have Consumers Been Deleveraging?

To be sure, consumers are borrowing less. They averaged $200 billion in non-mortgage debt from 2000 to 2007. After turning negative in 2009, it was a more modest $35 billion in 2010.

Mortgage debt requires deeper analysis to factor in foreclosures. Their data indicates three things; New mortgages have fallen because fewer people are buying homes. Charge-offs amounted to $1 trillion. Finally, while consumers were adding $130 billion a year up to 2007, by 2010 they were paying down $220 billion. Taken together, paying down mortgage and other debt represents a $480 billion change of course. So, yes, U.S. consumers have been deleveraging, massively.

“The switch toward paying down debt is probably reflected in restrained growth in aggregate consumption in the United States,” the authors note, with the emphasis on “probably.”

The caution is because not all debtors are alike, and they cite a recent paper by Paul Krugman and Gauti Eggerston. For Krugman and Eggertson, “’impatient’ agents borrow from ‘patient’ agents, but are subject to a debt limit. If this debt limit is, for some reason, suddenly reduced, the impatient agents are forced to cut spending; if the required deleveraging is large enough, the result can easily be to push the economy up against the zero lower bound.”

That of course, leads to another, empirical, consideration, the Fed researchers note: “A remaining issue is whether this deleveraging is a result of borrowers being forced to pay down debt as credit standards tightened, or a more voluntary change in saving behavior.” They find that “credit standards were tight through much of 2007-10. On the other hand, the reduction in housing and stock values over the same period may have led families to want to reduce their debts, in an effort to restore their net worth.”

Not terribly helpful in the short run. But that’s the virtue of economics: always more questions than answers.

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