Marking a Milestone

By: Dr. M. Ray Perryman
Published in syndication June 14, 2017

We recently passed a notable milestone in the long process of recovering from the Great Recession: household debt levels have surpassed the peak reached during the recession in 2008. In many ways, this rise in consumer debt is a good sign in that it indicates Americans are feeling optimistic enough to take on additional obligations. Moreover, housing markets and credit conditions have normalized to the point where mortgages are trending upward along with loan quality. On the other hand, it can be viewed in a somewhat more negative light in some respects, particularly given that one category responsible for significant growth is student debt which may not be providing adequate returns in terms of enhanced future earning capacity or other educational goals. Let's take a brief look at some of the salient points.

In 2008, when mortgage loans peaked during the early stages of the recession, total US household debt stood at $12.68 trillion according to the Quarterly Report on Household Debt and Credit maintained by the Federal Reserve Bank of New York. The vast majority (about 73%) was in the form of mortgage loans (at nearly $9.3 trillion), with the rest as credit card debt (6.8%), automobile loans (6.4%), home equity lines of credit (5.5%), student loans (4.8%), and other loans (3.3%). In the second quarter of 2013, the total outstanding household debt had dropped to $11.15 trillion, virtually all of which was the collapse of the mortgage market at the lower end. That segment fell to $7.84 trillion, with much of the drop reflecting workouts and foreclosures.

It wasn't until the first quarter of this year that we finally surpassed the prior peak. Most recently, total US household debt reached almost $12.73 trillion. (Note that this data is collected on a nominal basis, so part of the increase is due to inflation and the prior real level of debt as a percent of income has not been approached.) Of that total, mortgages were $8.6 trillion (nearly 68% of the total), which remains well below the pre-recession levels in 2007.

Looking more closely at the mortgage category reveals additional shifts. The peak level of mortgage debt was $9.29 trillion, which was reached in the third quarter of 2008. At that time, mortgage originations by risk score showed 8.83% of mortgages were originated to consumers with scores below 620 (the higher the credit risk score the less risk of default), while 35.87% went to consumers with risk scores above 760. As of the first quarter 2017, the composition of mortgage originations had shifted dramatically to only 3.61% with risk scores below 620 and 60.87% with risk scores above 760. The most recent data indicate that the number of foreclosures is less than one-sixth of that observed in early 2009. In other words, mortgage quality is dramatically improved.

The upward trend in student loans has been relatively rapid. In 2003, the total amount outstanding was about $241 billion. In just 14 years, it expanded by more than 5.5 times to the current $1.34 trillion. While borrowing to invest in one's human capital is often wise and prudent, the system has been subject to considerable abuse and many individuals are not receiving appropriate value.

Automobile loans have also risen as a proportion of total household debt. In the third quarter 2008, automobile loans were 6.38% of total household debt at $809 billion, By the first quarter 2017, automobile loans comprised 9.17% of total household debt at $1.17 trillion. The other sizable category, credit card debt, has actually decreased from $858 billion in 2008 to $764 billion as of the first quarter 2017.

The most recent national trends are fairly positive. Delinquency rates have improved notably since the recession and remain low by historical standards, but have increased slightly in recent months. However, delinquencies are rising in the automobile and credit card categories, and student loans delinquency rates remain high.

In Texas, total debt balance per capita (based on the population with a credit report) has increased relative to the US with the level rising from $37,110 per capita in 2008 to $40,240 in 2017. For the US, this debt balance per capita measure fell from $53,040 in 2008 to $47,650 in 2017.

The fact that US household debt has reached a new all-time high is not, in and of itself, a reason for concern. It's partly a sign that we've worked through more of the recession-related credit mess. Furthermore, given growth in the economy and household wealth and incomes over the past 10 years (as well as some inflation), the number remains lower on a relative basis than it was in 2008. On the other hand, although some of the crisis talk regarding student loans is arguably overblown (that segment is only about 14% as large as mortgages in 2008 despite the recent expansion), it is true that they are taking up a slice of the future incomes of young adults which might otherwise be used in a more productive manner.

Debt is a normal and essential part of the economy as well as an important mechanism to enable families to pay for college or a home. The simple fact that US households now have more debt than ever is really not a big deal, but there is some cause for concern in some of the underlying categories. Keeping debt at sustainable levels will require careful vigilance, ensuring that borrowers have the right information to make good decisions and working to keep college costs under control. I see no cause for immediate concern and, despite much noise to the contrary, I think we'll get there.