The Recovery's Silent Assassin Is Demographics

It's emotionally satisfying to blame the economy on people -- banks, borrowers, politicians -- because people can change. But the greater threat is demographic make-up of the country.


We've heard it so many places that we don't question it. Household debt is what's holding back the recovery in the US. Or it's Obama's fault. Or the Fed's. Or George W. Bush's. The only problem? It isn't true.We can think of household debt as comprised of two segments - mortgage debt and everything else.

Let's start with "everything else" - household debt minus mortgage debt relative to GDP. Since 1965 it has hovered in a range of 16% to 22% of GDP. Since 2008 it has fallen a couple points, and is back to roughly 1995 levels. It never had a huge run up in the 2000s. It's still elevated relative to the 1970s and 1980s, but with interest rates now far lower than they were then, the burden is manageable, with homeowner interest payments on consumer loans relative to disposable personal income (DPI) already back to early 1995 levels.

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Mortgage debt surged in the 2000s, and remains very elevated relative to historical norms. This is what the "new normalists" focus on.

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Three comments: First, we're making good progress. Mortgage debt to GDP has been falling by roughly 1% per quarter. At this rate we'll be back to normal in four years. Second, interest rates, and hence mortgage payments, are far lower today than they were in the mid 1990's. Back then mortgage rates were around 8%. Today they're below 4%. Mortgage debt servicing payments as a percentage of DPI is at 9.18% as of Q1 2012, its lowest level since Q2 2002. The low over the past 30 years was 8.67% in Q1 2000, and it's likely that by the second half of this year household mortgage burdens will be at a 30-year low. And third, just as it's not helpful to think about a "national average temperature," if you want to know the weather forecast, the breakdown of homeownership -- and hence mortgage debt responsibility -- matters.

For instance, while the overall homeownership rate at 66.1% is above the 64% it was at during the late 1980s and early 1990s, for all of the age buckets between ages 35 and 50, homeownership rates are already at 30-year lows (see Table 17).

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The overall homeownership rate looks like it still has room to fall because, 1) baby boomers, especially the older ones, never sold their houses - the homeownership rate for those age 55-64 is at 78.5%, and has averaged roughly 80% since the 1980s, and 2) as the population ages, and given that older people have higher homeownership rates than younger people, the overall homeownership rate rises.

OK, so the homeownership rate of people age 35-49 is at multi-decade lows. Why does this matter? Because young homebuyers power the US economy.

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Between 1982 and 2001 the number of homeowners ages 35-49 increased by almost 10 million, or 60% (see Table 12). Baby boomers were hitting their prime household-formation years and buying houses. Since that time age 35-49 households have decreased their homeownership by over 4 million houses - baby boomers aged and moved out of those age buckets, and because of economic uncertainty and its smaller size, Gen-X wasn't able to keep up (note: there was a big multi-year revision in 2002 that distorts these numbers a bit).

But here's reason for optimism. Millennials are now coming of age, as seen in the following chart - number of households by age. In 2011 we saw the biggest spike in households age 30-34 that we've ever seen. Household formation leads to homebuying. David Crowe of the NAHB said that 2 million new households were not formed because people moved back in with roommates or parents - in the chart below, you can see how the number of households ages 35-44 shrunk significantly over the past few years - those people are still here. This is classic pent-up demand.

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So let me tell my version of the 1982-2012 US economic story.

Beginning in the early 1980s the baby boomer generation, the largest in history, started hitting its mid-late 30s and bought houses at a normal rate. But even a normal rate for a big class meant a lot of house purchases and economic growth. Inflation and interest rates began a 30-year decline, fueling asset prices and household wealth.

By the mid-1990s, boomers had all hit age 35, so we weren't getting any new age 35-49 households. Instead, with the safety of a 10-year bullish trend behind them, boomers started increasing their homeownership rate. This peaked in 2005, but a once-in-a-lifetime credit boom led to exotic financing for subprime borrowers, pushing house prices and mortgage debt to unsustainable levels by 2007.

However, the number of prime age households had already peaked around the year 2000, the same time that robust economic growth did. Since 2007, boomers started retiring, easy credit went away and unemployment soared, financing a home purchase became difficult, home prices collapsed, households got scarred from the crisis, and Millennials haven't been quite old enough to step in and get things going again yet.

However, demographics have now troughed, and someday sooner than people think, Millennials -- on a debt-servicing basis probably the least leveraged group of 20-somethings in 40 years -- will take the jobs of their retiring parents and start forming households and buying houses.

It's emotionally satisfying to place the blame for our meager recovery on one's least favorite policymaker or political party, or turn it into a quasi-Catholic story of sin requiring penance, but demographics make a much more compelling case for what's happened and where we are, and point to a brighter future ahead.