Alasdair Macleod – 11 November 2009
Is US consumer debt falling?
The bubble that led to the credit crunch was consumer credit. Until that fateful day in August 2007 when credit markets seized up, asset prices were rising (though residential property had actually peaked in 2006) and Americans were borrowing. The borrowing was secured on inflated collateral.
As sure as night follows day, we expected the bubble to deflate; but the question was could it be deflated without causing serious damage, such as an Irving Fisher debt-deflation collapse? It was and still is fear of this possibility that has driven the Fed’s monetary policy, and why the Fed has more than doubled the monetary base. However, most of this increase in the monetary base remains on deposit at the Fed, and bank lending is contacting. This is reflected in the chart below, showing unadjusted household debt, which has declined from a peak of $13,866bn in March 2008 to $13,698bn in March 2009.
However, the broadest measure of unemployment, U6, has doubled from 8.3% to 16.2% in the two years from March 2007, and is higher still today. This is important, because 16.2% of the workforce is not in a position to make debt repayments. The rising unemployment trend is so sharp it is outpacing the fall in overall debt, and this is reflected by the blue line in the chart.
All this is very unscientific, but it is merely designed to reflect the deteriorating credit quality of US consumer debt behind the headline numbers. Those that think, as doubtless the authorities do, that we just need to play for a bit of time and our problems will diminish delude themselves. The household debt problem is still deteriorating and at an accelerating rate.
This does not auger well for attempts to kick-start consumer lending. Indeed, it indicates that the Irving Fisher debt-deflation spiral may already under be way, since banks are likely to respond to deteriorating consumer credit quality by reducing their consumer loan exposure more aggressively.
US commercial property
Debt in the US commercial property sector is also a developing problem due to falling property values, reflected in the second chart below. Property transactions have collapsed in 2009, as sellers have become reluctant to sell, and buyers reluctant to buy. Unlike most other financial assets commercial property shows no sign of recovery. Retailers are going bust and walking away from their rent obligations. There is a glut of hotels, and offices vacancies outside city centres are still rising.
The problem is compounded by gearing, with about $6 trillion’s worth of commercial property at the peak secured by about $3-3.5 trillion in loans. Property values have fallen to about $3.6 trillion, and current loans according to Fed statistics are $3.05 trillion (CRE loans plus CMB securities held by banks), giving an average LTV of 85%. Commercial property loans in the US are usually 5 to 7 years at origination, so the refinancing problem is substantial and increasing with unresolved problems accumulating. Banks are understandably having difficulty dealing with the problem because of the high LTVs and falling rental income, factors likely to push prices lower yet.
It is not as if the banks have much leeway, because Fed data shows total bank equity without adjusting for intangibles to be only $1.316 trillion, putting them in a perilous position from this problem alone.
A search of news sources and trade publications suggests that the commercial real estate problem will worsen until at least the middle of 2010. This is consistent with a 5-7 year loan roll-over and the build-up of problem loans. The strain on the banks’ capital in the face of accelerating bad debt provisions will be bad enough, assuming nothing else goes wrong for them.
This analysis runs against current economic sentiment. The rally in stock markets, and statistical evidence suggesting that the worst may be behind us is welcome relief for the investing classes. An alternative view is that zero interest rates have fed a stock market bubble, and that all the Keynesian and monetary stimuli were bound to have some stabilising effect, but Humpty Dumpty still remains in pieces. Yet another stock market bubble is no solution, merely an opportunity for the public to loose yet more money.