Monday, May 16, 2011

The Deleveraging of American Households

A week ago I featured the chart above showing that the household debt service ratio (red line) was 11.75% in the last quarter of 2010, which is the lowest ratio since the first quarter of 1998, and the household financial obligations ratio at 16.64% in Q4 2010 was the lowest since the first quarter of 1995. 

Dennis Cauchon has an article in today's USA Today that offers some explanations for the trend in the graph above: 

"Americans are reducing mortgage payments at a record clip, directing cash that once went for debt into consumer spending and savings. Low interest rates, defaults and refinancings have shaved more than $100 billion off the nation's annual mortgage bill — an amount comparable to all unemployment benefits for one year or this year's Social Security payroll tax cut.

Homeowners have trimmed interest payments alone by 11% — or $67 billion a year — from the peak in 2008, according to the Bureau of Economic Analysis (BEA). The savings come equally from grabbing lower interest rates and reducing what's owed by paying down principal or defaulting on loans. The nation has slashed total mortgage debt from nearly $11 trillion at the mid-2008 peak to $10.3 trillion in the first three months of 2011, the BEA reports."

MP: Many of the comments on the original CD post mentioned some of the same reasons for the significant deleveraging of American households over the last several years or more.  


At 5/16/2011 5:26 PM, Blogger bob wright said...

I know many people who have cashed out investments and used the proceeds to pay off their mortgage.

At 5/16/2011 5:45 PM, Blogger Larry G said...

In our neck of the woods in the exurbs south of DC - homes have lost between a 1/3 and 1/2 of their value and the rental market is hot, hot, hot.

I think at least some folks are getting out of homes that went underwater and no hope of recovering and have just walked away and have been able to rent other homes walked away from for much less than their original mortgage payments.

A LOT OF VALUE has been lost on homes.... and more and more folks are walking away from the mortgage and letting the banks figure out what to do with the property.

At 5/16/2011 6:03 PM, Blogger Benjamin Cole said...

The deleveraging is good. Mild inflation would help the whole nation deleverage too.

Imagine four percent inflation for six years--a lot like the 1980s, a boom decade.

That would effectively pay down about 25 percent of our bloated national debt. While easing mortgage payments for America's homeowners. While boosting property values--thus helping banks.

At 5/16/2011 6:09 PM, Blogger Larry G said...

people who have money are scooping up these walk-away homes....

teachers and deputies who had been saving for years for a home suddenly found they were much cheaper - a boon!

businesses in our area are, however, finding it almost impossible to get a loan.

Even going companies with established track records cannot get money.

and ... developers... developers of commercial properties - cannot get money.

A water-park company needed 200 million to start building their 800 million + park but or 3+ years have had little luck finding money.

We have mucho commercial retail and office building vacancies also.

At 5/17/2011 8:32 AM, Anonymous Anonymous said...

bob wright,

Why would anyone want to put money that could be put to much better use into a non-liquid, non-appreciating liability such as a home? A huge part of our current problem is people listing their house on the wrong side of their personal balance sheet and thinking they are wealthy. Homes are liabilities, but real estate/houses can be assets.

A move such as sinking your spare money into a home when mortgage interest rates are at the rock bottom only makes sense if you are trying to free up cash flow. There are much better ways to free up cash flow that giving up liquidity and locking your money into consumables such as your home.

Buy the best home you want to pay and live in for smallest payment and lowest interest rate you can find and just consider your mortgage principle and interest (p & i) payment as rent. You will always have an expense for property tax and house insurance anyhow, so just move you p & i to your expense column and be done with it. Your spare money can be leveraged and invested much wisely than sinking it into the same place you keep your bed.

At 5/17/2011 9:07 AM, Blogger bob wright said...

I'm not categorically in favor of this, I just observe that this happens. Since the financial crisis, this seems to be happening more [this is purely anecdotal].

Through the years, I have observed a change in people's psychology when they retire.

Eliminating the mortgage, even when it doesn't make sense mathematically, is one of those things I have observed.

Mathematically it doesn't make sense.

Psychologically, some people sleep better with the mortgage paid off; so they pay it off.

Since the financial crisis, when everything was uncertain, some people find comfort in the certainty of having the house paid for. Their comment goes something like ".... well, no matter what happens next, at least the house is paid for."

At 5/17/2011 10:01 AM, Blogger Larry G said...

two data points on mortgages and homes as wealth.

1. - Reverse mortgages seem to be an option these days for folks wo own their home free and clear but want the money now.

2. - Some assisted care living facilities will "trade" you for your existing home for a new home in their facility ..

At 5/17/2011 1:16 PM, Anonymous Anonymous said...

bob wright,

We can't easily put a dollar sign on peace of mind, can we? I would trade locked in equity for a liquid emergency fund first myself. I wonder what the weekly savings rate is for those who dump their mortgage. I'm in no hurry to pay off my $96.23-a-week/mortgage rent at 3.625% that allows me to save 27% of my gross pay per week.

Larry G
I don't consider my home as wealth anymore. It's worth almost the same as I paid for it 24 years ago ignoring inflation, so I have actually lost money on it. That's not the case with my other investments which have gained double-digit yearly returns in every ten-year period I have owned them including my real estate REITS. My personal home is like food to me as an investment--consumable.

At 5/17/2011 2:19 PM, Blogger Larry G said...

better to sell the house... rent..and put the excess into investments?

At 5/17/2011 3:55 PM, Anonymous Anonymous said...

"better to sell the house... rent..and put the excess into investments?"

That's very likely. There would not be any excess for me after 24 years of buying, so essentially I have already been renting. I have some freedoms as a "homeowner" that I would not have as a renter that would be difficult to quantify. All I am saying is not to let the emotional state of home ownership cloud sound investment strategies.

At 5/17/2011 4:03 PM, Blogger Larry G said...

but I've also heard that 401s were NEVER designed to be retirement plans....


At 5/17/2011 4:51 PM, Anonymous Anonymous said...

Viagra was designed for high blood pressure, but another use was found for it. Possibly the demise of defined benefit pensions will do the same thing for 401Ks.

At 5/17/2011 5:02 PM, Blogger Larry G said...

well.. they've basically converted the defined benefit plans to defined contribution ... de-facto 401k's..

And the reason that 401(k) were not designed as retirement plans was - investing... whether in home ownership or the stock markets is inherently risky.

We have thousands of people who are NOT retiring when they had thought they were when their 401(k) not only did not perform but tanked.

The question is - for a typical middle class person - where should they invest for their retirement if buying a house is not good and a 401(k) is risky?

At 5/17/2011 5:35 PM, Anonymous Anonymous said...

Larry G:

There are always risks, but here are my strategies that seem to vary in intensity between them over time. Spend way less than I make. Invest in my skill set to make my labor valuable to someone else. Save. Diversify. Think long term. Have a backup plan. Be versatile and adaptable to change.

Both a 401k and real estate can be suitable stores of wealth for retirement (commodities, houses etc. but not necessarily your home). You can ladder 1- to 5-year CDs to lower the risk of selling into a down market if you need immediate cash flow you can't supply elsewhere.

Not retiring would fit those strategies just fine as long as I have my health. I think we will see the notion of "retirement" redefined by the baby boomers whether by choice or need. Every generation defines their own normal.

At 5/21/2011 10:04 PM, Blogger VangelV said...

It looks to me as if there is a lot of defaulting going on as well. Why pay off a million dollar mortgage on a $580K house if you can just walk away? Of course, that is best done after consolidating all outstanding credit card debt by rolling it into a mortgage.

At 5/21/2011 10:11 PM, Blogger VangelV said...

The deleveraging is good. Mild inflation would help the whole nation deleverage too.

Whey you have a balance sheet recession you will get deleveraging even if interest rates are zero.

Imagine four percent inflation for six years--a lot like the 1980s, a boom decade.

Imagine 6% T-bills? How big would the deficit be then?

That would effectively pay down about 25 percent of our bloated national debt.

No, it would not. Your debt is of very low duration. No foreign lenders would buy T-notes in the face of high inflation so the big losers would be domestic savers and pension funds. Once the bond bubble starts to collapse the USD will no longer be enjoying the privilege of being the primary reserve currency and the American standard of living would collapse.

While easing mortgage payments for America's homeowners. While boosting property values--thus helping banks.

I don't think that you understand the nature of money. Collapsing purchasing power does not make people wealthier, even if they are heavy borrowers because there is no free lunch.


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