Despite the fact that his chosen profession- economics- has been called the “dismal science,” Dr. LaVaughn Henry, senior regional officer of the Federal Reserve Bank of Cleveland, is an avowed optimist. Although the recent recession was painful and long, he maintains we are fiscally healthier for it. “Americans have learned their lesson about savings and debt,” he says.
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To back up this claim, Henry points to a statistic called the “Household Debt Service Ratio,” which the Fed has been tracking since 1980. In layman’s terms, it measures how much of our income is getting sucked up by mandatory debt payments.
“Household Debt” is a combination of your mortgage payments plus the required payments you have to make on “consumer” debt- including credit card accounts- each quarter. This amount is divided by your quarterly disposable (after income tax) income to find the percent or “ratio” of debt-to-income.
Henry points out that the Household Debt Service rate is the lowest it’s been since the Fed began measuring it.
Household Debt Service Ratio
|Mortgage Debt Ratio||4.4%||7.2%||4.7%|
|Consumer Debt Ratio*||6.2%||6.0%||5.2%|
|Total Household Debt Service Ratio||10.6%||13.2%||9.9%|
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*credit card + non-mortgage loans
As Henry explains, “The mid-1980s was when credit cards became more available and home equity lending was much more in vogue. People started to bulk up on credit... because they found that it was easier to expand their credit lines than cut back on consumption.”
Translation: we used borrowed money to finance our elevated lifestyles.
According to Henry, the Household Debt Service Ratio took off “in a straight trajectory” that peaked in 2007. Not coincidentally, this was just before the financial markets crashed under the weight of subprime mortgages and lax lending policies.
Beginning with the official start of the recession in December 2007, the HH Debt Service ratio has steadily fallen, reaching 9.9% at the end of last July. In other words, debt payments today represent a smaller percentage of household income than they did more than 30 years ago.
That’s not to say Americans voluntarily stopped borrowing. In economics-speak, “forced de-leveraging was a major factor.” Translation: lenders foreclosed on bad mortgages and shut down credit, cancelling or setting limits on the credit accounts of over-extended consumers. In addition, Henry admits that “people who are credit-challenged are not applying for credit at the rate they used to. Maybe because they expect to get turned down.” At the same time, thanks to the “super-low interest rates” engineered by the Fed, some consumers have been able to re-finance outstanding debt and pay it down.
The same trend, i.e. reducing our dependence on debt- can be seen in the Federal Reserve’s “Financial Obligations Ratio.” This is a broader measure of how much of our income is earmarked for mandatory payments. It includes obligations such as property taxes, rent, auto leases and homeowner insurance. Again, at the end of July we were at a 34-year low.
Financial Obligations Ratio
In addition to reducing our reliance on debt. Henry points to another positive factor: we’re saving more. “In the mid-80s the personal saving rate peaked at 10%. And then from there on it declined to 2% as the use of credit continued to expand.” Again, it’s no coincidence that we sank to that all-time low in saving around 2005-2007-- just before the recession hit.
Since then, according to Henry, the personal savings has been rising. It reached 6.7% in June 2009- more than twice the rate of December 2007. By the end of the second quarter of this year it had declined to 5.6%. None-the-less, Henry maintains that Americans’ “balance sheets have improved even though they’re saving less than [immediately] after the recession.”
Then like a trained economist he cautiously adds, “How long it lasts remains to be seen.”
Next week: The source of Dr. Henry’s optimism and what we need to do to “move forward” economically.