It is popular among many these days to look at Europe’s debt problems and forecast a coming financial crisis that will be worse than the one suffered in 2008–09. It is also prevalent to reference the still-parlous state of household and government finances and to forecast another recessionary dip. Though such disasters are plausible, they are probably less likely than a muddling through of sorts, in no small measure because the private sector in the United States is in a much better position to cope with reverses today than it was back in 2008–09. Previous discussions in this spot have reviewed aspects of this improvement. This column looks at how the household and business sectors have lightened their debt burdens and how delinquency rates have improved as a result.

The record is plain. As the 2008 crisis broke, the American private sector moved dramatically to reduce its dependence on debt. From mid-2008 to the quarter just ended, the household sector cut its overall debt burden by a cumulative $689 billion or about 5%. Mortgage debt, naturally, fell the most, in part because of foreclosures, but also because households voluntarily reduced their exposure. Overall mortgage debt fell a cumulative $720 billion, or about 7%. For a while, consumer credit fell alongside the mortgage debt. Between mid-2008 and late 2010, installment, auto, home improvement, and credit card debt fell a cumulative $189 billion, or about 7%. But as the economy improved in 2010, albeit modestly, households very cautiously began to use such debt again. Growth rates, of course, have come nowhere near those of past years, when households increased such debt levels by 5–7% a year, but over the last four quarters, consumer debt of various kinds has crept up by some $56 billion, or about 2.3%.

Private business—financial, industrial, and commercial—have, if anything, exaggerated the behavior of households. Financial firms, understandably, have led. Since the end of 2008, for example, they have unburdened themselves of a cumulative $3.3 trillion in debt, a drop of near 20%. Non-financial business had less need to cut back, but did so nonetheless. Its efforts extended over 2009 and the first half of 2010, during which time it unburdened itself of some $378 billion of debt, a drop of more than 3%. From mid-2010 to the present, nonfinancial business, in response to the admittedly sluggish recovery, has begun a modest expansion with a similarly modest increase in debt levels. Though that debt pickup of $459 billion exceeded the previous drop, the annualized growth rate of 4.2% has fallen far short of the double-digit rates of debt accumulation averaged in earlier years.

The rise in government borrowing, of course, has more than offset this private prudence. State and local governments tried for a while to cut back on borrowing, but managed only slight reductions in a couple of quarters. On balance, since 2008, state and local government debt expanded by a cumulative $128 billion, or 4.4%. Still, the pace of growth was slower than in the past. More recently, these governments seemed to have gained a handle on their situation and actually have begun to reduce debt by some $51 billion, or about 2%, so far. It is, of course, the federal government that has gone in the complete opposite direction, raising its debt burden by a cumulative $4.8 trillion during this time, or some 90%. Almost entirely because of the federal debt explosion, overall debt in the economy has grown by a cumulative $4.5 trillion, or 13.6%.

If Washington’s profligacy has engendered understandable fear, the financial healing at household and corporate levels certainly has helped improve the delinquency and charge-off experience of lenders. In total, delinquency rates on all loans and leases at all American banks—that is, loans where the borrower is significantly behind on his or her payments—have dropped from a high of 7.3% of the amount outstanding in early 2010 to 5.66% in the summer quarter (the most recent period for which data are available). Charge-offs—that is, outright defaults—have fallen from a high of 2.98% at the end of 2009 to a mere 1.56% in this most recent period. Both delinquency and charge-off rates remain high by the standards of the more distant past, but they are considerably better than those recorded any time since the financial crisis back in 2008.

On residential real estate, delinquency rates hit a high of 11.25% of the amount outstanding in early 2010, and charge-off rates hit a high of 2.85% late in 2009. Both figures were down in the most recent summer quarter, to 10.23% and 1.52%, respectively. On commercial real estate, the improvement is, if anything, even more impressive. There, delinquency rates have fallen from a high of 8.76% of the amount outstanding in mid-2010 to 6.69%, while charge-offs have gone from a high of 3.02% at the end of 2009 to 1.21% during this year’s third quarter.

Outside of real estate, matters have improved even more. Delinquencies on consumer loans, for instance, including credit cards, have fallen from a high of 4.85% of the amount outstanding in mid-2009 to 3.15%, better than at any time since early 2007. Charge-off rates have dropped from a high of 6.78% in mid-2010 to 3.63%. Meanwhile, delinquencies among commercial and industrial loans have dropped from a high of 4.32% of the amount outstanding in late 2009 to only 1.8% in this most recent period. Charge-offs have dropped from their high of 2.54% in late 2009 to only 0.73% in this most recent summer quarter.

None of these figures, of course, paint a picture of absolute financial health. Debt levels, even outside government, remain unwieldy relative to incomes and more distant and reasonable historical benchmarks. In addition, delinquency and charge-off rates at banks remain high by the standards of the longer historical record. It generally exhibits chargeoff rates on all these sorts of loans at fractions of a percent and delinquency rates of 1–2%. But it should also be clear that matters have improved dramatically on all fronts, except government, during this past two and a half to three years. If the gains in financial health cannot erase all fears—and they most certainly should not—they are enough to put the private economy at least in a much better position than in 2008–09 to withstand reverses, whether produced overseas or domestically.

 

 

 

(c) Lord Abbett

www.lordabbett.com