Saturday, October 22, 2011

Consumer Deleveraging

The Wall Street Journal has an article (subscribers only as of Saturday morning), "Americans Debt Cutting Hampers Growth," which states that "Household thrift sparked by the financial crisis three years ago has proved surprisingly persistent and is a key reason the recovery that began in 2009 has been so weak."  To economists who study the effect and aftermath of financial crises, this is not a surprise and is a major reason why they have forecasted a sluggish economy for years to come since the start of the crisis.  Consumers accumulated a large amount of debt leading up to the crisis and now must deleverage to get their debt under control.  What led to the accumulation of debt?  Most people know the story by now.  The housing bubble made people feel wealthy, encouraging people to tap into that wealth through home equity loans, 100% (or more) financing of homes, etc.  When the bubble burst, the wealth was gone but the debt remained.  It will take an extended period of time to get debt back in line with wealth, thus constraining economic growth for years to come.  Here is a chart that compares the growth of household debt during recoveries from recessions since 1950.  As you'll notice from the chart, this time was different.