So tempting, so bad for you.

Your Debt, Our Nation's Headache

Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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On this day 56 years ago, the U.S. economy began to undergo a momentous change. It was Oct. 1, 1958, and the company known best for its Travelers Cheques introduced a new product: The charge card.

Although American Express technically wasn't the first company to introduce a charge card, it was the first to make its cards ubiquitous, and in the process changed the concept of where and how credit could be used. The nation hasn't been the same since.

From those humble beginnings, the use of credit spread throughout the county. The Depression-era generation was loath to become indebted to any bank or lender after seeing what could happen in a credit crisis. It's no coincidence that the widespread use of credit didn't occur until a new generation came of age.

Along with that new generation came the birth of the suburban bedroom community. Homes were bought with mortgages and furnished with revolving debt. Cars purchased with dealer financing were the glue that held the edifice together. All of these items were out of reach for the average family, unless purchased with credit. This is no small matter. As you can see from the Federal Reserve's most recent Flow of Funds report, the total indebtedness of U.S. households is a staggering $14 trillion dollars.

What makes the unstoppable rise of credit so significant is the role it played in the 2007-09 financial crisis, and the subsequent recovery. Credit crunches are different from ordinary recessions. Not only are they more severe, as Carmen Reinhart and Ken Rogoff have documented in "This Time Is Different: Eight Centuries of Financial Folly," but their character is significantly different.

Consider an ordinary recession: The economy begins to heat up as wages rise and consumers borrow and spend. The Fed, concerned about increasing inflation, raises interest rates. As credit becomes more expensive, sales slow, putting the economy at risk of slipping into a recession.

But fear not! After six months or so, the Fed then lowers rates, unleashing all that pent-up demand. Consumers and businesses begin spending again, folks get hired and the entire virtuous cycle begins anew.

That approach is what we have seen in the 15 or so post-World War II recession-recovery cycles. An overheating economy leads to rising rates leads to a slowdown leads to falling rates. Rinse, lather, repeat.

That isn't what occurs after a credit crisis such as the Great Recession. Assets purchased with cheap and widely available credit become worth significantly less once the bubble bursts. But the debt remains. All of that leverage used to purchase all of those assets -- regardless of whether it's subprime mortgages or dot-com stocks -- sticks around.

Hence, a post-credit-crisis recovery is dominated not by the release of pent-up demand, but by massive corporate, household and government deleveraging. Even before the financial crisis, Reinhart and Rogoff were detailing how and why recoveries from such events were such slow, protracted and painful affairs.

Until recently, most Wall Street analysts and economists misunderstood this. They used the wrong data set, looking at post-World War II recession recoveries as their frame of reference instead of post-credit-crisis recoveries. This is why their forecasts for the present recovery have been so wrong.

How wrong have they been? Aside from their usual bad predictions, having the wrong frame of reference means they are unaware of what is typical, what is likely, and where this economy differs from the norm.

A perfect example can be seen in the jobs data and the stock market. Ask most economists how these two indicators are doing, and you will get an answer along the lines of "The stock market is doing great, but unfortunately, the jobs data has been very soft."

That statement is true, if your frame of reference is the ordinary post-recession recovery. But if you are using the correct data set as your basis of analysis -- as we seen in this set of post-credit-crisis recoveries -- you reach a very different conclusion. Compared with the average recovery from the past 15 credit crises, this stock market's performance is subpar. And surprisingly, the jobs recovery is better than average.

Credit is a tool, one that can be used wisely or foolishly. No one held a gun to our collective heads and forced us to borrow and spend; the decision to live beyond our means was a choice too many of us made, both as individuals and collectively.

That doesn't mean we have to like it. Nor should we remain ignorant about the impact of credit's use and abuse. This is why we now find ourselves in a slow and unsatisfactory recovery. The deleveraging process continues, and each passing quarter brings us closer to a more normal environment.

Just don't expect Wall Street economists to recognize this until long after the fact.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editors on this story:
James Greiff at jgreiff@bloomberg.net
James Greiff at jgreiff@bloomberg.net