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Economic Insights

Governments, businesses, and consumers have had some success in deleveraging since the 2008–09 financial crisis, but the improvement has been uneven.

Deleveraging remains a hot topic in financial circles, as it has for some time now. That is only reasonable, since excessive debt did much to cause the financial crises of 2007–08 and the Great Recession of 2008–09. Elements of the economy have made progress ridding themselves of such financial excesses, but not all. Even where gains have emerged, matters remain spotty and far from historical comfort levels. The improvements have gone far enough to relive the worst fears, but they have failed to move sufficiently enough to justify an easy attitude and certainly not complacency.     

Intense Pressure at the Cyclical Trough
There can be little doubt that debt levels were oppressive as the economy hit its lows in 2009. During the prior 10 years, outstanding debt of all sorts in the United States had risen a sharp 7.0% a year on average. Meanwhile, the dollar value of goods and services had risen only 4.1% a year. That was quite a change from the previous 10-year stretch, 1989–99, during which debt and the dollar value of all output grew at about the same rate. The change meant that by 2009 debt had risen, from the 1.8–1.9 times the annual gross domestic product (GDP) during the prior 20 years to a striking 2.5 times.1 

The debt excesses were widespread, too. During the 10 years ended in 2009, even before all the spending of the present administration in Washington, federal debt levels had grown, on average, 7.4% a year, while receipts had risen only 1.6% a year. By 2009, federal debt, which 10 years earlier had stood at 2.3 times annual federal receipts, stood near 4.0 times. State and local governments had walked the same road as Washington. They had raised debt levels 9.7% a year, on average, between 1999 and 2009, even though their receipts had grown only 4.6% a year. Their debts stood at near 1.5 times annual receipts, up from under 1.0 times 10 years before. Households, too, increased debt faster than their ability to repay it, 7.4% a year on average for the 10 years up to 2009, compared to annual income growth of only 4.2%. Debt levels had risen, from about 0.8 times annual incomes to 1.1 times. Business was the best-behaved sector. Its debt use exceeded profits growth levels by a relatively narrow margin, 5.3% a year, on average, between 1999 and 2009, compared to earnings growth of 4.5%. Still, debt levels rose, from 4.0 times annual earnings in 1999 to 4.3 times in 2009.          

Progress Since the Cyclical Lows Has Been Uneven
If business’ finances had deteriorated least up to 2009, they have made the most progress since. From the 2009 cyclical trough to the second quarter this year (the most recent period for which data are available), business debt levels have grown, on average, a mere 3.5% a year, while earnings have increased 7.5% a year. Debt outstanding now amounts to about 3.5 times annual earnings, well down from the 2009 ratio of 4.3 times and actually better than at any time since the 1960s. State and local governments also have made remarkable progress during these years, despite all the headlines about Puerto Rico, Detroit, and the State of Illinois. Debt levels in this area actually have declined in aggregate, albeit at a slight 0.3% annual rate, even as receipts have increased 3.0% a year. The ratio of debt to annual receipts has improved, from 1.5 times in 2009 to 1.3 times today. That, too, is better than almost any time in the last 40–50 years, though these data do not include unfunded pension liabilities.

The household sector has made progress, too, but has not been as impressive as either business or state and municipal governments. Households have cut their mortgage debt by almost $1.0 trillion during these years of slow cyclical recovery, but have raised other debt levels, so that on balance overall household debt outstanding stands at about the same level as it was in 2009. Still, it is remarkable that households stopped the growth of debt at all. After all, during the 20 years up to 2009, household debt of all kinds increased by more than 7.0% a year. Meanwhile, annual income levels, even in this slow cyclical recovery, have increased 4.0% a year, allowing a decline in the ratio of outstanding debt to annual income, from 1.1 times in 2009 to 0.9 times. That is a notable improvement, but relative debt levels still remain high compared with the state of affairs in the 1980s and 1990s, when debt levels averaged between 70–80% of annual incomes. If, as it seems, the consumer is determined to correct past excesses, the recent hesitation to take on debt should persist a good deal longer, and, accordingly, consumer spending growth should remain constrained.

The problems with federal debt are well known, if not especially well defined. Unlike everywhere else in the economy, the federal government during this recovery has actually accelerated debt use from earlier, still rapid rates of increase. After growing a disturbing 6.5% a year during the 20 years up to 2009, net federal debt issuance during this recovery has notched up again, increasing 10.2% a year. Though federal receipts have accelerated, too, rising an average of 7.8% a year, they have failed to keep up with the additional debt. Federal debt outstanding, accordingly, has risen to 4.4 times annual receipts, up from about 4.0 times receipts in 2009. The burden on the economy has, undeniably, increased, especially when considering that these debt ratios averaged 2.2 times annual receipts in the 1980s and 1990s. This financial deterioration steals considerable flexibility from Washington, as is all too evident in daily media reports.

In Aggregate and Prospects
The balance of all this sector improvement and deterioration leaves an aggregate picture that has neither improved nor deteriorated since 2009. Total debt in the economy has increased, on average, about 3.9% a year during this cyclical recovery so far, about the same pace as the economy. The debt load—individual, public, corporate—remains where it stood in 2009, at some 2.5 times the dollar value of all goods and services produced in the United States. That implies a stress today that is little different from when the recovery began and considerably greater than it was in the 1980s and 1990s, when this ratio averaged 1.9 times. The suggestion is that the economy has limited flexibility. Because much faster growth would demand more debt, at least according to the norms of prior years, it looks unsustainable. Meanwhile, likelihoods point to a continuation of recent efforts to contain debt growth—by states and cities, households, and businesses—suggesting continued, slow spending growth, and so a persistence of the slow overall pace of expansion that has characterized this recovery so far.

(Note: I would like to thank Mark Pennington, Lord Abbett Partner, RIA Services, for suggesting this line of analysis.)

 

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