So a little while back, I created a post discussing aggregate consumer debt, and how it might be something we should be worried about. There were some good discussions and good points brought up. The discussion was largely predicated on this graph seen here, which aggregates total consumer debt – www.newyorkfed.org/microeconomics/hhdc.html
The Basic Issue With Our Current Debt… Debts Rising > Wages Rising = Bad, especially if that debt is higher than the time we went into a worldwide financial crisis due to debt.
In 2008, the financial crisis was largely caused by a massive mortgage debt bubble. As a result of this, many people have been looking out for debt bubbles that hit across a singular sector. But my general thought is it doesn’t really matter that much where the debt is coming from, it’s a simple matter of the cumulative debt burden that is placed on each household that will cause issues in the economy. People have been trying to pin debt problems down to one sector, such as the auto loan bubble, or student loan bubble. But very few have mentioned that it’s the aggregate debt that matters most, and small credit bubbles that occur across sectors can become very large when grouped together and added to other debts.
I noticed that current consumer debt levels are past where they were pre-financial crisis and the pace is steepening. The real kicker is that this has been happening at a time where household wage growth has been relatively small, and only in the past 1-2 years rose past the average per-household level we saw in 2007-2008. The lack of wage growth is evident in the fact that the fed has been unsuccessfully trying to spur wage growth for years, since it would validate their inflation targets that they have had a very difficult time of meeting.
The General Question at Hand…
Basic logic would dictate that if wages have only grown minimally while consumer debts have grown substantially, isn’t this going down a path that doesn’t end well? Also, while mortgage debts haven’t grown past where they were in 2008, other types of consumer credit (student loan debt, credit card debt, and auto loan debt) have shot total consumer credit past the aggregate debt levels seen pre-crisis. The other issue here is that mortgage debt tends to be the easiest to service, since mortgages tend to feature the longest term structure on average along with generally low interest rates. So if we are increasing shorter term debt that generally has a higher interest rate, this would probably put even more strain on the consumer, wouldn’t it?
Was There any Data That Validated These Issues?
Beyond the basic theory crafting here, it seems like there have been some real issues showing up in consumer reports in the past year or so. Auto Loan defaults are beyond where they were before the financial crisis. Student loan defaults are above 11% and have been rising for a while. Credit card delinquencies have been rising. This all has taken place at a time where the consumer savings rate has been dropping near an all time low, and consumer credit card debt hit an all time high after a huge spike in November.
But corporate earnings are great, so the economy must be good, right? ¯\_(ツ)_/¯ . The counter-argument to this of course could be that credit expansion has caused corporate earnings to look great.
Who knows, this may not be the case, and that’s somewhat of a separate discussion altogether so I don’t want to side track the point of this post.
Now, there are some reasonable arguments to be made that credit growth is due to consumers being more confident in the future of the economy, but consumer confidence frequently been a contrarian indicator that leads recessions, so I’m not sure this would make me feel better. Also, if this were consumers simply being more confident, why are we seeing the credit issues with student loans and auto loans?
The Debt Servicing Problem
So all the information that was previously mentioned looks like it checks out… The theory makes sense, the debt levels are real, and there are some issues showing up in consumers’ ability to meet their debt obligations, so what is the problem?
So in the previous post, there was a very interesting statistic brought up in that discussion by u/enginerd03 and a few others that seemed to refute everything that I brought up above. That stat was FED data on debt servicing, which basically shows consumers’ ability to meet their debt payment obligations, which if you look at the data, looks quite rosy. You can see some fed data on debt servicing here:
This threw me through a loop. Something in the logic completely doesn’t add up here. How could debt servicing be so good here, while credit was expanding, some issues meeting obligations are starting to show up, all in a rising rate environment? My initial reaction was to literally say wtf… I assumed the data was right and there was something I was either missing completely, or I was simply wrong.
The Missing Piece, and Why I think We May Be Underestimating Consumer Strain
Recently, I think I found the missing piece. The devil is in the details here. If you look at the two above links, you’ll notice that the top home payment debt servicing exclusively shows servicing for mortgages. The consumer debt servicing looks a good bit worse as it has been rising since 2012, possibly due to rising non-mortgage credit. With that said, neither of these look like they tell that great of a story considering that according to the second link, consumer debt servicing was worse before the 2001 tech crash than during and after the great recession.
Regardless, it’s relevant to understand how consumer debt is accounted by the fed. The fed charts here account for consumer debt by adding up mortgage debt, credit card debt, auto loan debt, and other small loans and revolving credit issued to consumers. Together, all of these debts account for a large majority of the fixed expenses that people pay on a monthly basis. With that said, they do not include one really important expense…. RENT.
A Brief Rundown on How Rent Has Changed Things
Rent as we all know, is a major fixed expense. In this regard, it’s not all that different from a mortgage payment, with the exception that in the event of non-payment, the renter is not liable for the rest of the money owed, and will instead get evicted. I’ll touch back on this in a short bit.
So as everyone knows, the housing bubble busted, many people lost their homes, many speculators lost a ton of money, and the real estate market went bottom up. This resulted in the Dodd-Frank act passing, and much tighter lending conditions being enacted on people. The aforementioned factors led to a significant shift in how Americans pay for their housing. Instead of burdening themselves with excess liabilities, especially in the face of tighter lending conditions, Americans increasingly have decided to rent.
There are other factors at play as well. Young Americans have had more and more difficulty mustering up the 20% downpayment that is generally needed to make a mortgage significantly more affordable. This can be attributed to many factors, but student loan debt and lack of wage growth in the middle class likely play in here (see how this is related?).
Average rental price has grown significantly, going from around $1050 in 2007 to $1359 in 2017 (according to RentCafe ). This represents a 30% increase in monthly costs for rent. More importantly, the volume of renters has increased greatly since the financial crisis as a result of the factors mentioned above. Rentals as a percentage of households increased from 31% in 2006 to over 36% currently – see pew research article for more info.
So while we have not seen the huge growth in debt in the housing sector of consumer debt, this is because it’s being offset by enormous growth in renters. And the reason renters are renting more and buying less may be partially due to being squeezed in other areas of consumer debt, which makes it extremely tough to save enough $ for a home down payment.
Rent vs. Mortgage Payments, not Apples to Oranges
Yes, I know, rent is not the same as paying for a mortgage. You can’t go bankrupt if you don’t pay rent. With that said, rent is essentially a fixed cost for the majority of consumers that is essentially a basic requirement of living, so you can’t just count it out of the equation of consumer cost burdens.
Also, while rent is accounted for in consumer debt measurements by the FED or many other data researchers, it’s highly relevant to state that the rent being paid by rentees goes to a landlord, who DOES pay a mortgage. This means that the debt burden is simply being passed from consumer debt to commercial debt in the statistics, which tends to skew things. And make no mistake, renters not being able to pay their rent will lead to landlords defaulting on their mortgages (although there is likely a bit more cushion here). I have seen mentions of a commercial debt bubble in the United States before, which could be related, but I haven’t done much reading or delving into this topic to be able to comment on it.
Revising the Data
So what we really want to see is how consumers are being squeezed from a fixed cost perspective, which results in increased credit growth and increased inability to make payments.
So what I did was take the data provided by the fed (total mortgage debt outstanding) and divided that by the amount of households in the United States. This provides us with an average of how much outstanding debt on average each household owes. I calculated households by taking US population and dividing it by the average person per household (generally around 2.6, but it has decreased a little bit since 2007). Naturally, average mortgage payment includes households that do not pay for mortgages at all, so it will look a little bit low in the chart below.
Since I couldn’t find data on this, I had to go with a very rough estimate on average monthly mortgage payment. So I took the average outstanding mortgage debt per household and put it into an amortization table estimating an average of 20 years left and a 4.5% interest rate. Clearly this isn’t going to be perfect from a data perspective, but it is at least uniform throughout each year, and should provide a good snapshot comparison of the REAL costs of paying for a home are from 2007 to 2017.
I then took the average rent payment (which I mentioned above) and averaged that out on a per-household basis, so that similar to mortgages, it accounted for the entire population of households and not just people who are renting.
From there, I added the two together to get more of a REAL look into the average cost of paying for housing. It turns out that housing costs didn’t drop nearly as much as we thought after the financial crisis, the costs just shifted more from mortgage expenses to rental expenses.
edit: See the link below for the data I crunched. (anyone know how to format something as a table? would be nice to show it in the post)
Re-evaluating earlier data with new information
So with the knowledge that more Americans are renting, and rental costs are increasing, if consumers are being squeezed, we should see more evictions, right? Well this turns out to be true and the obvious reasons why are also backed up with stats.
Also, lets revisit that debt servicing chart from earlier (fred.stlouisfed.org/series/CDSP). It turns out that it’s not so strange after all, we are getting pretty close to the range that we were in right before the markets crashed in both 2000/2001 as well as 2007/2008. And notice the dip in that chart after the great recession from around 2011 to 2015? That correlates strongly with the data in the table above, where housing payments were down slightly in that time frame. And similarly, the time frame from 2011 to 2015 which featured the lowest housing payment costs correlates well with an increase in personal savings rate, which is as of 2017/2018 near an all time low.
Given, correlations do not = causation, but none of this is “good” in any manner.