In 1986, disposable personal income rose 5%, but personal debts rose more than twice as fast:Mortgage debt was up 13%and consumer credit rose 12%.
Since Americans have been taking on debt much faster than their incomes have grown for several years, both interest payments and debt are at record levels relative to disposable personal income.
Some worry that if interest rates were to rise or incomes were to fall, record numbers of families would default on their debts, bringing down the financial system.
Truth Is Complicated
Others point to the rising values of homes and stock market investments and argue that there is no problem.
As is usually the case in such arguments, the truth is more complicated. The real problem with personal debt is not that it will bring down the financial system but that it lowers the supply of funds available for industrial investment.
In theory, personal savings are supposed to help finance industrial investment. In fact, in the United States during 1986, individuals were net borrowers of $100 billion (2.4% of the gross national product) to finance their housing and consumer durable purchases.
No society can be competitive industrially if the household sector has a negative savings rate. It just won't have as much capital equipment per worker as its competitors.
By itself, household debt, even if there were to be substantial defaults, is not going to create great difficulties for the financial system.
The problem, however, is that bad household debts do not exist in isolation. They coexist with excessive Third World loans, bad farm debt, worthless oil loans and deep-in-debt firms. Together, all of these bad debts place the U.S. financial system in a very exposed position.
But what are the real chances that there will be a lot more household defaults in the next recession or the next period of rising interest rates?
If one looks at average assets and average debts, the average family isn't in trouble, but those figures are misleading. The assets are held by one group of families and the debts by another.
Don't Own Homes
The bottom half of the population has 20% of total income but 38% of all mortgage debt and 31% of all consumer debt.
Fifty-five percent of that less-well-off group does not own a home, while 72% of all corporate stocks are owned by the top 10% of the population.
Rising stock values offset little of the extra debt taken on by the bottom half of the income distribution, and in most parts of the country, housing values are not rising.
Even within the bottom half of the income distribution, there is a very uneven distribution of debt. Most families have little or no debt, but there is about 20% that have taken on huge debts and are incredibly exposed.
Even a small reduction in income could put them over the edge.
Some are counting on rising values of stocks to bail out the household sector, but those values are unpredictable.
The stock market can go down as fast as it goes up, but debts will not go down as stock prices go down. What are the probabilities that stocks will go down? To answer that question, you have to have a theory as to why stocks have gone up so rapidly.
I suspect that it is due to the flow of foreign funds into the United States. Foreigners are moving more than $150 billion per year into the United States, and given today's relatively low interest rates on short-term bonds and the expectations of further declines in the value of the dollar, the stock market becomes the only foreign hope for preserving the value of their U.S. investments.
The alternatives--real investments in property or direct investments in U.S. firms--simply take too much time and too much management for the amount of money that must be invested.
But when the flow of foreign money slows, as it inevitably will, the country is apt to be faced not just with a problem of finding the funds to finance its traditional borrowers but also with a falling stock market.
The value of government, corporate and household assets will fall simultaneously. Thus, the stress and strains of higher-than-expected defaults are apt to occur in many of the weak sectors at the same time.
In theory, the 1986 tax revisions should reduce the use of consumer credit since interest payments other than for mortgages will no longer be tax-deductible. In fact, however, the new tax law has stimulated borrowing by inspiring the development of home-equity loans. Banks are now encouraging Americans to set up home equity accounts where they can essentially write checks on the unused equity in their homes.
This "technological breakthrough" may very well end up stimulating more household borrowing than the new tax law discourages.
Perhaps household debt shouldn't be high on your list of economic nightmares, but don't leave it off.