America on a debt diet

If you are overweight or obese, there are two ways to get fit, healthy and back to the right weight.  You can do more exercise and you can eat less.  Most scientific surveys show that the latter is  does the trick more than the former, but you need both.

What’s true for the human body is also true for the body economic.  The American capitalist economy is struggling to recover from the biggest slump it has experienced since the Great Depression of the 1930s.  Humans cannot run faster if they remain fat and America’s economy won’t grow fast enough to create jobs in an economy where 17% of the labour force are unemployed or underemployed unless it can remove the excessive weight of debt bearing down on it.

In a previous post (The overhang of debt, 1 March 20101) I argued that the huge increase in private sector credit that fuelled the property boom of the 2000s was really what Marx called fictitious capital.  It was not an accumulation of assets with real value like factories, technology or skilled labour, but assets that had fictitious value, like company shares or property.

Eventually, any slowdown in the growth of real values would expose the hollow nature of this fictitious capital.   And indeed, the buyers of all that debt in mortgages and other forms of borrowing, found that the asset prices held as collateral started to collapse and homeowners defaulted and banks went bust.  The credit crunch and the Great Recession ensued.

Until that mountain debt can be cut back by bankruptcies, write-offs and payments, the profitability of new investments will be curbed and so will capitalist economic growth.  American capitalism has to go on a debt diet.

But dieting that works takes time and discipline.  If history is any guide, deleveraging usually takes several years – at least four and often as much as seven, according to studies by the McKinsey Institute and Reinhart and Rogoff.  This time will be no different.  In the meantime, real GDP and consumer spending growth will stay below trend.

The increase in debt experienced by the major developed capitalist economies, particularly between 2001 and 2008 was unprecedented.  Between 2000 and 2008, the compound annual growth in public and private sector debt was 8-10%.  Overall debt outstanding in the major economies rose 58%, led by a 66% increase in household and financial sector debt.  Such increases would suggest that the process of deleveraging will be longer and more painful than it has been after previous crises.

So how far has debt dieting gone?  According to the latest Federal Reserve bank statistics, the short answer is not very far.  Total US debt (public and private) is now higher than it was at the end of 2007, although it has been falling since Q1’09.  The main reason that the US economy is deeper in debt than before the financial crisis began is the rise in public sector borrowing.  In effect, more debt has been piled on existing debt – apparently the answer to obesity is to eat more.  Since end-2007, government debt (including the now state-owned mortgage lenders Fannie Mae and Freddie Mac – so-called GSEs) is up 72%, while financial sector debt is down 9% and households have reduced their debt by nearly 3%.  The non-financial business sector has raised its debt by 2.6%.

Dieting has gone the furthest in the financial sector.  The big debt reductions have been in the writing-off or redemptions of mortgage-backed and other asset-backed securities.  The value of these securities and the debt they represent has dropped $5.2trn, or over 60%.  The debt securitisation market has died.

The largest sector in the economy and the one which drives consumption and corporate sales, the household sector, has reduced its debt by $380bn, or 3% since end-2007.  Indeed, households went on adding to their debt right through most of 2008 before borrowing peaked at $14.6trn.  Household debt now stands at $13.9trn, down 6% from its peak.  That is the biggest fall in household debt in modern times.

But more is needed.  Household debt may be down $650bn from its peak, but the value of household assets (both real estate and financial assets) is down 20 times more, namely $12.4trn, or 16% from its peak in Q3’07!  As a result, the ratio of household liabilities relative to assets jumped from 17.7% in Q3-07 to an all-time record of 22% by the beginning of 2009 and is still above 20%, as opposed to the trend average of about 17.5%.  In that sense, the debt burden of American households is worse, not better.

The drop in asset value has been repeated in the business sector, if not quite to the same degree.  US Inc is flush with cash.  Corporate cash levels are up from $580bn at end-2007 to $920bn.  But the value of non-liquid tangible assets has fallen by more than six times as much.  Commercial real estate values have fallen by one-third from $9.3trn at end-2007 to $6.5trn now.  The overall fall in corporate business assets is $2.2trn, while debt has risen by nearly $1trn, as companies issued paper to finance their businesses.  As a result, the business sector debt to assets ratio has reached a level not seen since the recession of the early 1990s.

That’s not good news to sustain a rise in profitability.  In the last significant recession of the early 1990s, the business debt-asset ratio also rose sharply – it’s a function of recessions.  But then the ratio soon improved because there was a sharp recovery in corporate asset values.  Indeed, corporate debt continued to rise – so there was no dieting at all.  But this time it will be different.  In this crisis, corporate asset values have plunged to such an extent that any recovery in asset values will be insufficient to restore healthy balance sheets that will encourage businesses to sustain new investment.  This time debt will have to be reduced as well.

Deleveraging in the private sector has been small so far because the cost of servicing that debt has fallen.  US mortgage rates are at record lows.  Personal interest payments as share of personal disposable income are also at record lows.  In that sense, the economic recession and Fed monetary policy has enabled the body economic to avoid dieting too much.  But the debt (excess fat) remains.

5 thoughts on “America on a debt diet

  1. Great post, Michael!

    The discrepancy between the drop in households’ assets and household debt that you call attention to helps to account for the very small drop in consumer spending, to date, as a consequence of the drop in wealth. This suggests that, unless the government and the fed find some way to keep the household debt machine going, the slow destruction of paper wealth will dampen consumer spending in piecemeal fashion for a long time.

    Do you know of any statistics that might tell us the portion of the delevering that is due to repayment of debt vs. the portion that is due to writing-off of bad debt?

    1. Andrew
      The fall in household debt from its peak in mid-2008 has been $650bn. According to the Federal Deposit Insurance Corporation, the net charge-offs by US commercial for defaults on mortgage debt and consumer credit since mid-2008 is about $300bn. And the net charge-offs recorded by the now state-owned mortgage lenders Fannie Mae and Freddie Mac are probably about $70bn (as far as I can tell). So something like 55-60% of the decline in US household debt is due to defaults on debt rather than paying down. I suspect this is an underestimate.

  2. “Eventually, any slowdown in the growth of real values would expose the hollow nature of this fictitious capital. And indeed, the buyers of all that debt in mortgages and other forms of borrowing, found that the asset prices held as collateral started to collapse and homeowners defaulted and banks went bust. The credit crunch and the Great Recession ensued.”

    Fictitious or not, it is that “any slowdown in the growth of real values” that we need to occupy ourselves. If fictitious capital is fictitious then it simply cannot be the cause for greater extractions of value, or the slowdown in the growth of real values.

    In fact there was such a slowdown not in the growth of value, but in profitability, in the rate of growth of profitability, in the rate of return onf capitalist production. That rate peaked in 2006 [talking about non-financial, the manufacturing and industry], coincident, surprise-surprise, with increased capital spending and a modest increase in wage rates. In a word– overproduction– in semiconductor fabrication, in maritime transport vessel production, in oil production, coal etc.

    I don’t think the slowdown in household debt accumulation bodes ill for corporate profitability– industry, manufacturing have made an historically record recovery in profitability, with the profit share of the profit + wage mass at or near its WW2 high. How did they do this? Beating the snot out of the working class is the phrase that comes to mind. Not to mention, beggaring thy neighbor, and thy neighbor’s neighbors. God bless our brave currency speculators.

    Not exactly fictitious capital, but rather– all capital become fictitious when it cannot reproduce itself quickly, and profitably enough.

    1. Artesian
      In my post I did not mean to suggest that profitability was not key to the health of capitalism. On the contrary, anybody who has read my book, The Great Recession, or any of the posts in this blog, would know that it is exactly profitability that I highlight. What I was arguing in this post was that falling profitability in the productive sectors of the US economy after 2005-6 (as you say) accelerated the expansion of credit and speculation in non-productive sectors like financial markets and real estate. The rise in asset values there was fictitious and not based on increased value from labour power. It was funded by huge increases in debt. These fictitious assets would eventually collapse under their own weight. That’s what happened in the credit crunch. But the debt that financed these assets remained. Until it is sufficently written off (along with real productive assets and people’s jobs), profitability of capital is not restored sufficiently to begin a new upward swing in capitalist production. Such is the level of debt generated in the last cycle (and really since 1997) – and it is not just in the financial and household sectors but also in the corporate sector – it will keep new investment growth weak for some time to come. I’ll return to this theme in my next post.

  3. Yeah, I agree with all that. I would point, to amplify, that the shift of banks and financial institutions to the “consumer markets”– home mortgage etc.– was brought about in part by the determination of industry to restrain operating and capital spending after the 2001-2003 recession.

    The mix of “assets” on bank balance sheets went from about 50-50 before 2003, to 30% business 70% consumer. For some years after 2001 until [I think] 2004, the “replacement rate” for plant and equipment [cap spending / depreciation] was less than 1.

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