POLITICS: PennAve

Americans taking on more debt

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PennAve,Joseph Lawler,Economy,Student Loans,Wall Street,Housing,Magazine,Credit Scores

Of all the trends that led to the economy picking up at the end of 2013 and beginning of 2014, perhaps the most underlooked was that U.S. households stopped reducing their debt.

After nearly five years of saving money and paying down debt, Americans finally stopped tightening their belts halfway through last year, with aggregate household debt bottoming out at $11.1 trillion. Over the last half of 2013, consumers added more in loans, led by mortgages, for the first time since Wall Street's collapse.

In the fourth quarter, households added $241 billion in debt, the largest increase since the third quarter of 2007, according to the Federal Reserve Bank of New York, which, with the credit reporting service Experian, tracks household debt.

Unfortunately, it's not obvious that rising housing and consumer debt, which would be normal in a healthy economy, is a good thing for the U.S. right now.

One problem is that the end of de-leveraging hasn't been accompanied by strong income growth. With the labor market still roughly 6 million jobs shy of full health, wage growth has been slow. The result is that total household debt is about the same as total disposable income, meaning that Americans are still relatively highly indebted.

Furthermore, the fastest-growing component of personal debt has been student loan debt, which is countercyclical. People head back to school when jobs are scarce, and students take out bigger loans when paychecks are slim.

The run-up in student loan debt -- to more than $1.1 trillion, more than any kind of personal debt other than mortgages -- has drawn attention from top policymakers, including Federal Reserve Chairwoman Janet Yellen, who noted in a recent congressional hearing that "the concern there is this is debt that will be with students for a very long time. If they get into financial difficulties, that debt stays with them."

There is a growing recognition among economists since the financial crisis that changes in household debt can play a major role in driving the business cycle.

In a forthcoming book, House of Debt, economists Atif Mian of Princeton and Amir Sufi argue that struggling homeowners in the wake of the housing bubble's collapse were more central than the failure of banks in pitching the economy into a recession and causing millions to lose their jobs.

The two economists push back against what they call the "bank-lending view" — that the failure of Wall Street banks like Lehman Brothers cut off lending and thus crimped consumer spending, slowing economic growth. Instead, they promote the "levered-losses view," which focuses on the fact that the homeowners who were most overextended when the bubble burst were low-net-worth people who then had no choice but to pull back on spending when their homes went underwater, depressing the broader economy. They note that spending was slowing in late 2007 and early 2008 — after the bubble burst, but before Wall Street blew up.

Mian and Sufi are not the first to come to the conclusion that household borrowing is at the heart of the economy. In a 2010 paper titled "The Leverage Cycle," Yale professor and hedge fund manager John Geanakoplos proposed that leverage, not the interest rates that central bankers obsess over, is the most important variable in explaining financial crises.

All three economists, during the depths of the recession, argued that cutting principal for underwater homeowners was the best way to spur a recovery.

As for how to prevent future crises involving household debt, Mian and Sufi suggest introducing "shared responsibility mortgages" that would automatically reduce borrowers' principal in case of falling home prices and give the lender a share of the upside if prices rise.

But the first step, Geankoplos has said, is for the Fed simply to begin to monitor consumer and banking leverage, and take steps to limit the debt accumulation before the next bubble inflates.

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