The Alarm Over Consumer Debt Is Overblown
It’s probably not going down anytime soon. But have consumers really levered up since the end of the recession? No. The raw levels are misleading. Household debt as a percentage of disposable income continues to fall:
Consumers are really still deleveraging. Moreover, note that while household debt grows, the pace of growth is sharply slower than prior to the recession:
Finally, the combination of low interest rates and ongoing deleveraging means that housing financial obligation levels are near series lows:
I don’t see a consumer debt problem at an aggregate level. But what about at a sector-specific level? It is no secret that households have been taking on substantial debt in two areas, student loans and auto loans:
Is there a shoe about to drop in these sectors?
I think about that question in two ways. First, what are the sector- or consumer-specific issues? Second, are there substantial implications for the broader economy?
Consider student loans. Because the vast majority of these are held by the federal government, it is almost impossible to imagine a systemic crisis emanating from widespread delinquency or default (in most cases, student loans cannot be discharged via bankruptcy). The taxpayers may take a hit, but the buck mostly stops there.
But they aren't likely to trigger a national crisis, student loans could curtail some future spending. College graduates with loans, for instance, are less likely to own a home than those without loans.
But even here the picture is not so clear once you recognize that college graduates with loans are still more likely to own a home than those who did not complete college. In other words, if access to student loans allows more students to invest in additional capital by completing college, then net future spending will rise relative to the alternative few workers with a college education. So college loans might not be so bad after all. The alternative might be worse.
Likewise, I don’t think auto lending in general, and subprime auto lending in particular, is likely to trigger a systemic financial crisis. To be sure, losses in the sector are rising, but the sector is small relative to overall lending and certainly to the size of the U.S. mortgage market. According to the New York Federal Reserve, overall auto loans, of which subprime has represented about 25 percent in recent years, amounted to $1.2 trillion in the first quarter of the year, compared with $8.6 trillion of mortgage debt.
Still, like student loans, auto loans could cause some sector-specific problems. The Federal Reserve Loan Officer Survey, for example, reports tighter lending standards and weaker demand for auto loans. That adds weight to my belief that auto sales peaked for the cycle last year and are not likely to rebound soon.
To be sure, if you are a shareholder of Ford or General Motors this should concern you. But just how much of an impact will slower auto sales have on the overall economy? Here, again, perspective is important. In 2016, motor vehicles and parts contributed just 0.08 percentage point to economic growth. It’s not nothing, but it’s not a whole lot either.
The bigger picture is what the debt scare stories are telling us about investor psychology. Many remain shell-shocked by the last financial crisis and as a result keep looking for a repeat in every corner of the market. Hysteria over consumer debt is essentially a case of fighting the last war. It is important to not fall into the trap of extrapolating from sector-specific problems to impending doom for the overall economy as we saw in housing.
That path will lead to excessive bearishness, especially in the mature stage of a low growth expansion. The data just will not be as consistently positive as during the early stage of the expansion. There will be plenty of soft data that could drag investors down the wrong path of expecting too much economic weakness if they don't carefully differentiate between sector-specific and economy-wide impacts. And remember that like the housing bust differed from the tech bust, it is more likely than not that the next downturn won't look like the last.
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