U.S. household debt has finally fallen back to pre-recession levels. So, we’ve finally learned our lesson about spending more than we make, right? Well, not really. The real reason our debt has dipped is that so many Americans defaulted on bills they couldn’t pay.
Moody’s Analytics and the Federal Reserve released a batch of figures last week showing a significant dip in U.S. household debt. According to Moody’s, the combined amount owed on our home mortgages, credit cards, and other outstanding liabilities have gotten down to about $11 trillion, which is about what it was in 2006. Federal Reserve numbers show that household debt as a share of disposable income dipped to 113% in the second quarter of 2012. It hit 134% in 2007, right before the recession.
So how exactly did we finally got our debt under control? A growing sense of fiscal responsibility has certainly played a role. This, after all, is the era of extreme couponing; and after years of out-of-control spending on bigger and bigger houses, we’ve become a nation of renters. A number of polls also show that we believe we are more frugal and cost-conscious than before the recession.
The decline in household debt, however, doesn’t necessarily mean we’ve changed our ways. In fact, says Mustafa Akcay, an economist at Moody’s, “nearly 80% of deleveraging is caused by defaults.” Only 20% of the decrease comes as a result of what he calls “voluntary deleveraging,” i.e. the hard work of paying down our debts faster than we borrow.
“Most of the decline in outstanding aggregate debt has been defaults,” agrees Brookings Institution economist Karen Dynan, who last year analyzed financial institution charge-offs of loans that have gone bad and found that the value of defaults was about two-thirds as large as the total decline in household debt.
Still, Dynan believes that defaults have become a lot less important over the past year. She cites Federal Reserve data showing that charge-offs by banks for mortgages and consumer loans have dipped recently. She also attributes lower debt levels to a reduction in new borrowing — though that’s not necessarily a sign that consumers are any less willing to borrow. “Banks are being super-cautious about lending,” she says. “There is a substantial group of households that have much less debt now simply because they have not been able to get loans because terms are so tight.”
Ackay says that if Congress avoids the coming fiscal cliff – a combination of expiring tax cuts and federal spending cuts – lower debt levels are likely to give the economy a significant boost. “We could say that Americans are getting their finances in order,” says Akcay. “They are positioning themselves to take on more debt and spend more of the rest of their income.”
“With the lower debt burden and record low borrowing costs, households are positioned to fill in the gap in 2013,” he adds. “Whether they will or not depends on how policymakers address the fiscal issues.”