Peak Debt Part 1: Household Debt
Series: Peak debt
A confluence of driving forces nudges the global monetary system toward a reset, with deflation leading the charge.
Part 1 of the peak debt outlines the logic for this phenomenon and examines one of the debt components – household debt starting with mortgage debt.
Part 2 of the peak debt series digs into the auto and student loans component of household debts.
Part 3 of the peak debt series examines the state of corporate debt, how it is used and where it is heading.
In our previous article Deflation, debt and the monetary reset we argued that a confluence of economic, financial and geopolitical driving forces is steadily pushing our current monetary system toward a reset. And we further argued that one of the key factors is debt at all levels, and that peak debt will likely contribute as the most important driving force to said reset.
For those who have just dialled in, the line of reasoning goes like this:
- Economic growth since the 80s has been by and large fuelled by debt expansion and debt growth has substantially outpaced growth in GDP.
- Further economic growth is dependent on continuous outsized debt growth.
- World economies either have or are pretty close to having reached a point where the borrowers or lenders or both are saturated with debt.
- Without growth, the ability to service the existing stock of debt, which is practically impossible already at this stage, would become even more diminished.
- Debt defaults would set off a wave of deflation (destruction of credit) which would trigger more defaults, completing the vicious circle in the process.
As personal/household, corporate and public debts are at different stages of reaching peak debt, we begin the series by first examining household debt, for the simple reason that household debt is the easiest to relate to and understanding the concept of peak household debt requires the least amount of mental acrobatic manoeuvres.
Liquidity vs Solvency
Before going further, let’s first clarify some terminology. As it is not uncommon to see mainstream media journalists use the terms liquidity and solvency inappropriately to describe an economic situation as if the terms are interchangeable, it is important to get this seeming misconception out of the way.
If you have a steady income which is comfortably above your level of expenses but you are hit by an unexpected bill (e.g. an expensive and unexpected auto repair bill), and you do not have cash on hand to cover the cost, you need to dip into either your credit card or line of credit. You pay off this short term loan over a relatively short period of time with money from your paychecks. In this case you have a liquidity problem which you bridge over with a short term debt.
If your expenses consistently exceed your income, you can continue to borrow money short term to bridge the gap. But as your debt continues to pile up, you eventually max out on your credit card and line of credit. Worse still, if it gets to the point where the income minus expenses can no longer cover the interest of the debt, at that point you are driven into bankruptcy. In this situation you have a solvency problem.
Fortunately, before you get to the point where your debt load exceeds your ability to service the interest of same, either you come to your senses and stop adding more debt, or the maxed-out line of credit would impose the discipline on you. Whatever the causes may be, you have reached peak debt at the individual level.
Whether an individual reaches peak debt depends on a variety of economic as well as psychological factors, including one’s current income, income prospects (career stage, age, etc.), current/anticipated discretionary and non-discretionary personal expenditures, level of savings and current debt level. Naturally, therefore, it varies greatly from individual to individual.
However, when we look at entire demographic segments in aggregate, the overall well being of the ‘herd’ paints a pretty accurate picture of where the segment is in terms of its level of indebtedness and its ability to take on more.
Household Debt: the Big Picture
To understand where we are in the debt cycle, let’s take a look at the overall US consumer debt. Except for student loans which will be covered below plus other minor nuances, the overall household debt level of the US is not particular good or bad compared to other developed economies. Therefore, the observations from this country should more or less apply to others.
As of the end of 2013, the total consumer debt stands at US$11.52 trillion.
Total debt outstanding came down from its peak in the wake of the financial crisis in 2008 and has been on a downtrend until 2013 when it began to rise again. During that time, there has been a lot of hype from mainstream media touting the great deleveraging of the Americans to the tune of $1 trillion, a refreshing social phenomenon indicating that the general population was finally coming to their financial senses would have been encouraging if it was actually true.
Reality, however, was a lot more sobering. Instead of doing the responsible thing of paying down debt voluntarily, the reason the total amount of debt went down was, sadly, the result of some $800 billion in mortgage debt write-down due to defaults since 2007.
If the fact that consumer debt is on the upswing again should spell relief to those who count on an ever increasing amount of debt as the source of happiness and prosperity and everything will now be back to the way it was again, they should think again.
A peek under the hood of the composition of consumer debt would lead one to conclude that the debt dynamics in the next decade would be very different from the one just past.
The subprime mortgage crisis in 2008 had turned a large swath of home owners underwater when the value of their homes became less than the mortgage they owed. While the housing market has rebounded remarkably since and, in some case, home prices especially in the high end in selective bubble markets have exceeded those prior to the crisis, the recovery has been uneven and still leaves large segments of home owners stranded in negative equity territory.
To wit, the national negative equity rate is still at 15.4%, and, multi-million dollar homes in San Francisco and New York City notwithstanding, 46% and 32% of low end homes are still under water in Atlanta and Baltimore, respectively, according to Zillow (link).
Furthermore, consider these:
- A lot of the recent home purchases were made by private equities and hedge funds who raised a huge amount of capital thanks to the tsunami of liquidity unleashed by the Fed and turned themselves into absentee landlords. Another source is overseas buyers from such countries as Russia and China who are trying to move capital out of their country.
- With median income declining for the 99% since 2008, the rise in home prices make homes even less affordable than prior to the financial crisis.
- Despite mortgage rates at generational lows and lending standards gradually eroding towards the subprime crisis level, mortgage originations have essentially flatlined.
- Millennials with dim employment prospects and saddled with a crushing burden of student debt (see next article) are either incapable of or deferring household formation.
By and large, it is highly doubtful that mortgage debt will be accumulating once again in any significant way in the foreseeable future.
In our next article on peak debt, we will examine non-mortgage household debts: Peak Debt Part 2: Auto & Student Loans