Debt burden

Ezra Klein responds to my post on middle class debt with this chart. I hope he'll forgive me for ripping it off, but it's hard to talk about without looking at it.


Says Ezra:

scarychart.jpgSo this stuff is increasing. The "all debt as a share of income" number is particularly worrying, as it's increased as much in the 2000-2005 period as in the 1979-2000 period. Megan might say it's all a function of asset bubbles, but economists I've talked to say the upper-bound estimate for the impact of asset market bubbles is half of the decline in the savings rate. Significant, but not, on its own, the whole story. So something is going on here. And I'm not the only one who thinks so. Michael Mandel, the chief economist at Business Week, calls the following graphic "the world's scariest chart," and while I don't think it quite compares to this one, it's not far off

I would argue that this doesn't tell us what we really want to know, which is: how much is this debt costing us?

Look at the first chart. What's striking is how much the top line differs from the bottom line. If what we were seeing was America plunging itself into debt to finance consumption, they should all be rising roughly in line with each other. In fact, the top line breaks away from the others.

What's going on here? Ezra misstates just slightly: it's not all debt as a share of income, it's all debt as a share of disposable income. That is to say, income after taxes. In 1949, personal disposable income was 95% of GDP; by 2007, it was 89%. So part of that increase is simply that the share of income dedicated to taxes has risen substantially.

That is not, of course, the entire story. There's also the fact that in 1940, homeownership rates were around 45%; it's now almost 68%. All of that transition was financed by debt, and not only by debt, but by a dramatic shift in the type of debt: the emergence in the 1950s of the thirty year fixed-rate amortizing mortgage as the dominant form of home financing. Prior to that, mortgages had been much shorter, and usually featured balloon payments.

Meanwhile, the dramatic rise in effective income taxes on the middle class at federal and state levels made the mortgage interest tax deduction much more valuable, encouraging people to take on more debt. As you can see, most of the increase is actually housing debt.

On the revolving debt side, you'll notice that the largest increases take place in the 1950s, 1960s, and 1970s, is basically flat in the 1980s and 1990s, and then ticks up again in 2000.

This represents a number of different trends: first there was the auto loan revolution in the 1950s and 1960s; then came the introduction of Diner's Club, shortly followed by Amex, in the 1960's. Almost all of this debt was either secured by automobiles, or paid off each month; the latter represents float, not real revolving debt.

In the 1970s, the effective repeal of bank usury laws made Mastercard and Visa ubiquitous, causing debt to march upwards again. This is actual credit expansion. But it's hard to be sure how much, because this era is the death of another kind of debt: installment buying.

If people massively expand their asset base by a house and a couple of cars, not to mention labor-saving appliances like dishwashers and washing machines, 40% of it all debt financed, this is not an obviously worrisome trend. Especially since a lot of that represents a shift from expenses like rent to debt payments, which is not actually a net deterioration in people's finances. Nor is it clear that we should mourn for the days when the repo man could take away your furniture, television, and appliances.

There's another trend buried in there that matters a great deal: the secular decline in interest rates that began in the 1980s when Paul Volcker, then chairman of the Federal Reserve, went postal on inflation. As interest rates fell, debt rose as a percentage of disposable income, but that's because people could afford more debt on the same payment. This does not represent a material adverse change in peoples' circumstances.

Now, in fact, I agree that people overleveraged themselves in the last eight years, encouraged by ultra-low interest rates; that is now showing up in the DSR, which is now rising toward 15%. But I do not agree that this is the sort of financial holocaust that some argue. The housing bubble peaked in late 2005, meaning that we are now deep into the weeds of negative equity and teaser resets. This year should be the worst for mortgage performance, and yet the most recent figures show that the worst quality loans, subprime, have an overall foreclosure rate of 2% and a delinquency rate of 14%. These are not happy numbers--they represent hard times for a lot of families. And I expect that they will rise still further in the next report, due out in early June. But that's not "demise of the middle class" level; subprime ARMS, the problem market, account for only 7% of outstanding loans.

Nor is this as unique as many commentators seem to believe. The percentage of people who had negative net worth was about the same in 1962 as it was in 2000, the latest census year. The middle class certainly isn't in nearly as bad shape as it was in the 1980s, when high interest rates combined with falling inflation to make the debt they had hella expensive.

I am not trying to be a Pollyanna. Americans need to pay down some debt, and that process will be unpleasant. But they have adequate resources to do so, and the debt they have taken on largely represents an improvement in living standards and a transition to an ownership society that I think is overall a very good thing. More importantly, I find little evidence for Elizabeth Warren's claims about why Americans have all this debt--which is to say that they're being forced into it by heartless capitalism, a lzay government, and rising inequality.