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Debt fragility persists in the US household sector [ClearOnMoney]
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Debt fragility persists in the US household sector

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Commentary

Debt fragility persists in the US household sector

26 Jun 2012 by Jim Fickett.

Although total household debt in the US has come down substantially since 2007, the value of assets has come down even more, lessening the flexibility of families in servicing remaining debt. In addition, among lower-income families, where resilience in facing cash flow problems is already lowest, net worth has deteriorated the most, and leverage has also increased. All this suggests that household debt issues are likely to be as much of an issue in the next crisis as they were in the last one.

The difficulties faced by families in the next financial crisis (yes, there will be one; we just don't know when) will be determined in large part by variations in the ability to service debt. If someone with no savings and marginal income buys a house with no down payment, and the value of the house falls, then any interruption in income is fatal. On the other hand if someone with high net worth increases leverage only slightly to buy a house, then fluctuations in income can be managed by dipping into savings.

On the positive side, household liabilities have come down substantially since 2007 and, over the past several decades, as debt has in general risen, interest rates have in general come down, keeping the cost of servicing debt in a fairly narrow range (US household financial obligations ratio remains near long-term average).

Although the cost of servicing debt in normal times is important, a major determinant of the severity of a crisis is how people and institutions deal with interruptions in cash flow. I.e. balance sheets are important too.

The Fed's Survey of Consumer Finances, which gives median values of a number of financial variables in different income percentile groups, gives some idea of where the debt problems might be concentrated.

For example, the percentage increase in debt from 1998 to 2004 was highest in low-income quintiles. More specifically, for the first four income quintiles and the top two deciles, the increase in debt per family was 261%, 170%, 131%, 90%, 103%, 93% respectively. This trend could have provided some warning of the subprime crisis.

The results of the 2010 survey came out this month, allowing us to compare the previous post-crisis period, using the 2001 survey, to the present one, using 2010 data.

From 2001 to 2010, the net worth of most families deteriorated. So although debt has come down a lot recently, so have assets. For all income groups except the 90-100 percentile group, net worth dropped below the 2001 level in the 2010 survey. This is not a good sign for financial resilience.

Here is the percentage change in net worth from 2001 to 2010, in each income percentile group.

Percentile group Change
0 - 19.9% -35.4%
20 - 39.9% -44.2%
40 - 59.9% -15.5%
60 - 79.9% -27.3%
80 - 89.9% -11.1%
90 - 100% +16.9%

Again this looks bad – the two largest percentage declines are in the lowest two income groups.

Net worth is assets minus liabilities. Leverage is liabilities divided by assets. The leverage data has both positive and negative aspects.

The highest leverage, and the largest increase in leverage, both occur in the 60-80 percentile income group. These are people with higher than average incomes and substantial net worth. Hopefully that means that in the next crisis, even if they feel considerable stress, most will find a way to cope.

However there is bad news too, in the leverage data – namely that in all the lower income quintiles leverage increased from 2001 to 2010.

All told, the latest Survey of Consumer Finances suggests that, even though total sector debt has come down, the stress for the household sector in the next crisis will probably be as bad as it was in 2007-2009.