In the run-up to the Financial Crisis, household debt as a share of disposable income in the United States reached significant highs. Most of this debt came from mortgages, and during the housing boom, mortgage debt outstanding soared to records. The extent of people financing their homes through leverage is what caused this debt binge. When it all crashed, the result was the sharpest rate of household deleveraging we’ve seen.
As Blackrock’s Global Macro Outlook for May points out, US household debt relative to disposable income has now reached its lowest levels in 14 years. The analysis further mentioned:
“This deleveraging is also driven by the post-crisis financial system clean-up. Stricter regulations have boosted bank capital have also led to tighter lending standards. That has made it harder for less-creditworthy households to borrow, unlike in the last cycle when growth was powered by an unsustainable debt binge and lax lending standards.”
In nominal terms, household debt has actually exceed its previous peak from 2008. The nominal term however, does not account for inflation, population growth, GDP, and of course leverage. When you account for these factors, we see much more favorable conditions in terms of household debt than in 2008. This deleveraging should result in households being much less vulnerable to economic shocks.
Debt Binge over? Corporations Leveraging Up
While households have been deleveraging at a sharper rate than during any post-war cycle, corporations have been leveraging up at a sharper rate. With low interest rates globally since the crisis, corporations have found financing through debt more alluring. The report from Blackrock touched on the subject by noting:
“Companies naturally took advantage of record low rates to conduct a balance sheet arbitrage by issuing long-term bonds, partly with an eye to cutting outstanding equity. A desire to boost shareholder returns in the short term added to the incentives for emphasizing debt over equity on the balance sheet.”
In April, the IMF issued a report warning that the high leverage in the corporate sector could pose a major threat to the financial industry. As the Fed raises interest rates, the report notes the risk that higher borrowing costs could bear on firm’s ability to service debt. Some companies in the energy, utility, and real-estate sectors are earning less than twice their interest expense – a seemingly troublesome scenario given a rise in short-term interest rates.
When it comes to private debt, it appears households and corporations have traded places since the last cycle. Although one could argue businesses are acting exactly how the Fed had planned when they dropped the short-term rate to zero, one hopes these trends remain sustainable.
You can find the IMF report mentioned, here