Lately, there has been quite a bit of excitement that the big overhang of debt left over from the financial crisis may be starting to ease. Treasury Secretary Timothy F. Geithner has noted that there’s been a “significant reduction” of debt, and a number of indicators point to American households getting their finances in better shape.
But there’s still big debate between the world’s top economists and President Obama about whether more should have been done to address the debt overhang. Here’s the story of that overhang – in 10 charts.
When the housing market collapsed, Americans were left with all the debt they had taken on during the housing bubble. But their homes were worth much less, leaving families buried in debt.
The following chart shows how home values (the red line) declined greatly, while mortgage debt (the blue line) has only come down a tad.
While all economists agree that this has been a problem, some have argued the problem has been largely offset the Federal Reserve’s policies, which have dramatically reduced interest rates. Homeowners may have huge debts, the thinking goes, but they have been able to refinance at historically low interest rates.
In this chart, the blue line shows the Fed’s benchmark interest rate, while the red line is the 30-year mortgage rate.
This is all certainly true, and it’s a good thing. In general, even if people have large total obligations, they are paying a much lower proportion of their income to service that debt.
But this doesn’t capture the whole story. The overhang of debt – and who’s burdened by it – isn’t evenly distributed among the population. Federal Reserve Chairman Ben S. Bernanke hinted at this in a speech during the summer: “Exclusive attention to aggregate numbers is likely to paint an incomplete picture of what many individuals are experiencing.”
While many have been freed of onerous debt burdens, a significant part of the population still has a big debt problem. These are underwater homeowners – people who owe more on their homes than the properties are worth. Corelogic reports there are approximately 10.8 million of these homeowners, or 22.3 percent of all homeowners.
Karen Dynan of the Brookings Institution has calculated that about 24 percent of borrowers carry too much debt, up from 22 percent three years ago. These people – often in the middle class -- were hardest hit by the decline in home values and overhang of mortgage debt. Wealthier people had it easier. Amir Sufi of the University of Chicago, using data from the Federal Reserve, shows how much wealth was lost among people of modest means in the recession.
Not only that, but underwater homeowners have not been able to refinance and take advantage of ultra-low interest rates. See this chart from Sufi about U.S. counties with many or fewer underwater borrowers.
The following chart, based on data from the Fed’s Survey of Consumer Finance, shows that among people with a low net worth, the proportion that is paying more than 40 percent of their income toward debt has surged from 2007 to 2010. Among people with higher net worth, it declined. (The blue line titled <25% represents the bottom quartile of
Americans by net worth).
Some economists – Sufi of the University of Chicago and Atif Mian of Princeton - have suggested that this debt overhang has weighed heavily on consumer spending, which represents the lion’s share of economic activity, in both the recession and the recovery. In this chart from Sufi, the black lines show auto sales in zip codes where few homeowners are underwater, while the red lines show auto sales in zip codes where many are underwater.
We still have a long way to go. The following chart from Dynan shows the percentage of households that need to pay down their debts to reach more sustainable levels. For instance, 2.7 percent of households need to save just about a month of income, while 4.8 percent of households need to save between 6 and 12 months of income to get there.
Still, there’s hope. Home prices have started to increase. As values go up, people become less underwater – reducing the amount of “negative equity” in the economy. This chart is based on data from CoreLogic.
And as Sufi notes, home price increases are happening fastest where the housing bust – and the hangover of debt – was greatest.
Put it all together and household debt has weighed on the economy in a way many people don't appreciate, but there seems to be progress toward addressing it.