Trends in the Household Balance Sheet

The Federal Reserve Bank of Chicago has released an interesting Chicago Fed Letter written by Francois Velde. He addresses the issue: "Are U.S. households carrying too much debt?" Concern about households' levels of debt is understandable. Over-indebted households might cut back on consumption and thereby dampen economic growth. They might also file for bankruptcy.

Evaluating the long-term changes in the household balance sheet is not a trivial task. We need to consider changes in the relationship of debt to income over a long period of time to gain perspective on the issue. Over the period from 1950 to 2000, households' assets grew at roughly the same rate as the gross domestic product (GDP). In other words, households' assets grew at about the same rate as the economy. In contrast, over the past 50 years consumers' liabilities have grown from 24 percent to 78 percent of GDP. Put another way, the ratio of consumers' assets to their liabilities has fallen from 14:1 to 6:1.

Under the section heading, "Debt is good," Velde observes, "Household debt is a means for households to transfer resources from [future] times and circumstances in which they are less needy to those in which they are more needy." Young households "borrow to bring forward part of the future income they will enjoy in their prime, and use it to buy a house now." Obviously, there are constraints on consumers' ability and willingness to transfer funds from the future to the present. Lenders also have constraints. However, as lenders become more efficient in assessing risk, they also become more willing to extend credit to borrowers who wish to "bring forward part of their future income." To the extent that government interferes with the ability of lenders to assess risk and adjust credit terms to reflect that risk, it will impede consumers' ability to pledge future income to accommodate today's needs.

At the end of the first quarter of 2002, households' debt consisted mainly of mortgage debt (67 percent) and consumer debt (27 percent). From 1984 to the first quarter of 2002, mortgage debt grew from 40 percent to 73 percent of disposable personal income. The striking rate of growth in mortgage debt is attributed to a number of factors. First, there was a significant rise in home ownership from 64 percent in 1984 to 68 percent at the end of 2001. This increase was facilitated by a decline in the size of down payments required. Second, the shift to long-term debt should not be viewed as creating more stress on consumers' debt burden. To a great extent, consumers' mortgage payments replace rent payments. Third, as householders make mortgage payments, the increasing equity in their home provides collateral for additional borrowing if needed. In recent years, as house values have increased, home mortgage debt has grown at the same rate.

With all this home mortgage debt outstanding, will the economy "go down the tube" if there is a significant increase in interest rates? No. The author points out that "in a closed economy one person's liability is another person's asset." The author concludes: "The degree to which financial distress can affect aggregate consumption depends on the comparison between debtor and creditor behavior, and it is not obvious that high debt burdens (such as they presently are) signal an imminent curtailment of consumption."