In the first class, we saw how the household savings rate fell from over 10% around 1980 to roughly 0% in 2007, and has risen to roughly 5% in the past seven months. Here we examine what has happened to household debt. The Federal Reserve maintains a balance sheet for the household sector. The balance sheet consists of all of the debts and assets of all of the households of the United States. These contain both financial assets, such as stocks and deposit at banks, as well as real assets such as houses and cars. The data reported here are part of the Flow of Funds put out by the Federal Reserve. For more information check out the
Flow of Funds page at the Fed.
Figure One plots (all of the figures are also availble in a
pdf) the amount of debt held by households relative to income. People generally feel that the more debt a person has, the worse is their financial position. We can see from figure one that from 1980 to 2006, household debt relative to income rose tremendously. Of particular note is the acceleration in the amount of debt relative to income starting around 2000.
Having debt is not necessarily a bad thing. Debt is important to be able to buy assets that we cannot buy with our current income, but that we can buy using our lifetime income. This is the idea of student loans and using a mortgage to buy a house. Along these lines, a lot of people were arguing that the rise in debt after 1980 would not be a problem because it was accompanied by rising wealth. Figure Two plots the net worth of households relative to income. Net Worth is the value of all assets less the value of debt owed. We can see that after 1980 household net worth was indeed rising, suggesting that the rising debt levels were justified by increases in wealth. A striking feature in figure two are the twin bubbles of the tech stock (around 2000) and the housing market (2006). These large swings in net worth happened at the same time as the explosion of debt around 2000.
FigureThree plots the ratio of debt to assets. This helps us see if the rising debt was backed up by purchases of assets. This picture suggests that not all of the rise in debt was offset by rising assets. Figure four compares debt/income to debt/assets. For both series I have divided them by their level in 1952. Thus, we get a sense for how much each series has moved the last 57 years. From figure 4 we see that debt/income and debt/assets generally move together. However, beginning around 1995, debt/income rose while debt/assets fell. During this time period many experts were arguing that the rising debt/income was not a problem since debt/assets was actually falling. However, we now know that the low level for debt/assets was due to
assets being overvalued due to the tech bubble. Once the tech bubble burst in 2001, debt/assets caught up to the debt/income level. Around 2003 debt/income againg took off while debt/assets went flat. Once again many experts, argued that this was not a problem because the rising debt was being offset by a rise in assets values--this time housing assets. We now now what happened: the housing bubble burst in 2007 and debt/assets rose, trying to catch up with debt/income.
Figure 5 plots the value of houses and the stock market relative to income. For the value of houses, we use
home equity. Home equity is the amount of money a household would get if the household sold their house. It represent the value of the house less the value of the mortgage on the house. We can see from figure five that home equity has roughly the same value to households as the value of their stocks. However, we should be careful when we say this, since most the stock held by households is held by the top 5% of the wealthiest households. The bottom 95% hold most of their wealth in the from of bank deposits (not in figure 5) and home equity. Therefore, the large swing in the value of home equity from 1998 to now was most likely felt more by the average American household. Also, note that if a household ignored the housing bubble, that, relative to income, home equity is the same as it was in 1999. A lot of the problems we are facing are that a lot of people thought the increase in home equity was permanent.
Focusing more squarely on the housing market, figure 6 plots the value of mortgage debt relative to income. Here we see a huge surge starting around 2000. Figure 7 plots the value of mortgage debt relative to the value of housing. The higher is the amount of mortgage debt relative to the value of the house, we say that households are more
levered in housing. We refer to the amount of debt used to purchase an asset as the amount someone is levered in that asset. For instance, when a house is purchased, a homeowner typically only pays for a part of the house, called the down payment, and borrows the rest. Essentially, the amount borrowed acts as a lever, raising the amount of housing that can be purchased with the cash used for the down payment. The lower the down payment, the higher is the leverage. We can see that from 1995 to 2005 that housing leverage was not increasing even though the amount of mortgage debt was exploding. Of course we all know the result.
Last, figure 8 compares mortage debt/income to housing leverage. Once again, I divide each series by their value in 1952. Here we see mortgage debt rising. However, when mortgage debt rises it takes a while for leverage to also increase. However, in every instance we see that leverage does eventually rise. From 2001 to roughly 2005, we saw mortgage debt take off, while leverage remained constant. Many people were arguing that the rise in debt was not a problem since it was backed up by the rise in home values. These people were ignoring the data before 2000. We can see from figure 8 that a rise in debt eventually leads to an increase in housing leverage--it is just delayed. If we think of the average household as only owning housing, then we can see that the average American household is now more levered than ever. Therefore, as we saw in figure 5 home equity may be back where it was in 1999, but the amount of debt owed for the that home equity, given by the amount of leverage, is at an all time high. The high rates of foreclosure are quite understandable: the real value of houses are not worth more than in 1999 (relative to income) but households have to pay more for them.
Figure One plots (all of the figures are also availble in a pdf) the amount of debt held by households relative to income. People generally feel that the more debt a person has, the worse is their financial position. We can see from figure one that from 1980 to 2006, household debt relative to income rose tremendously. Of particular note is the acceleration in the amount of debt relative to income starting around 2000.
Having debt is not necessarily a bad thing. Debt is important to be able to buy assets that we cannot buy with our current income, but that we can buy using our lifetime income. This is the idea of student loans and using a mortgage to buy a house. Along these lines, a lot of people were arguing that the rise in debt after 1980 would not be a problem because it was accompanied by rising wealth. Figure Two plots the net worth of households relative to income. Net Worth is the value of all assets less the value of debt owed. We can see that after 1980 household net worth was indeed rising, suggesting that the rising debt levels were justified by increases in wealth. A striking feature in figure two are the twin bubbles of the tech stock (around 2000) and the housing market (2006). These large swings in net worth happened at the same time as the explosion of debt around 2000.
FigureThree plots the ratio of debt to assets. This helps us see if the rising debt was backed up by purchases of assets. This picture suggests that not all of the rise in debt was offset by rising assets. Figure four compares debt/income to debt/assets. For both series I have divided them by their level in 1952. Thus, we get a sense for how much each series has moved the last 57 years. From figure 4 we see that debt/income and debt/assets generally move together. However, beginning around 1995, debt/income rose while debt/assets fell. During this time period many experts were arguing that the rising debt/income was not a problem since debt/assets was actually falling. However, we now know that the low level for debt/assets was due to assets being overvalued due to the tech bubble. Once the tech bubble burst in 2001, debt/assets caught up to the debt/income level. Around 2003 debt/income againg took off while debt/assets went flat. Once again many experts, argued that this was not a problem because the rising debt was being offset by a rise in assets values--this time housing assets. We now now what happened: the housing bubble burst in 2007 and debt/assets rose, trying to catch up with debt/income.
Figure 5 plots the value of houses and the stock market relative to income. For the value of houses, we use home equity. Home equity is the amount of money a household would get if the household sold their house. It represent the value of the house less the value of the mortgage on the house. We can see from figure five that home equity has roughly the same value to households as the value of their stocks. However, we should be careful when we say this, since most the stock held by households is held by the top 5% of the wealthiest households. The bottom 95% hold most of their wealth in the from of bank deposits (not in figure 5) and home equity. Therefore, the large swing in the value of home equity from 1998 to now was most likely felt more by the average American household. Also, note that if a household ignored the housing bubble, that, relative to income, home equity is the same as it was in 1999. A lot of the problems we are facing are that a lot of people thought the increase in home equity was permanent.
Focusing more squarely on the housing market, figure 6 plots the value of mortgage debt relative to income. Here we see a huge surge starting around 2000. Figure 7 plots the value of mortgage debt relative to the value of housing. The higher is the amount of mortgage debt relative to the value of the house, we say that households are more levered in housing. We refer to the amount of debt used to purchase an asset as the amount someone is levered in that asset. For instance, when a house is purchased, a homeowner typically only pays for a part of the house, called the down payment, and borrows the rest. Essentially, the amount borrowed acts as a lever, raising the amount of housing that can be purchased with the cash used for the down payment. The lower the down payment, the higher is the leverage. We can see that from 1995 to 2005 that housing leverage was not increasing even though the amount of mortgage debt was exploding. Of course we all know the result.
Last, figure 8 compares mortage debt/income to housing leverage. Once again, I divide each series by their value in 1952. Here we see mortgage debt rising. However, when mortgage debt rises it takes a while for leverage to also increase. However, in every instance we see that leverage does eventually rise. From 2001 to roughly 2005, we saw mortgage debt take off, while leverage remained constant. Many people were arguing that the rise in debt was not a problem since it was backed up by the rise in home values. These people were ignoring the data before 2000. We can see from figure 8 that a rise in debt eventually leads to an increase in housing leverage--it is just delayed. If we think of the average household as only owning housing, then we can see that the average American household is now more levered than ever. Therefore, as we saw in figure 5 home equity may be back where it was in 1999, but the amount of debt owed for the that home equity, given by the amount of leverage, is at an all time high. The high rates of foreclosure are quite understandable: the real value of houses are not worth more than in 1999 (relative to income) but households have to pay more for them.
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