In a recent article in McKinsey Quarterly called “Working Out of Debt,” the venerable consulting firm tracks past deleveraging processes and compares them to the current process in the US, UK and Spain.
In a nutshell for the US, households appear to be about a year and a half away from reducing debt as a percentage of disposable income, to a rising trend line that would be at about 100% at mid-2013. If, for example, the US was to follow a similar deleveraging path as Sweden, we can expect such deleveraging to continue to go below that trend line and bottom out in about four years.
Interestingly, due to declining debt levels and lower interest rates, the US household debt service ratio has declined from its peak of 14% in the third quarter of 2007 to 11.5%, lower than it was in 2000.
Household debt outstanding has fallen by 4 percent from the end of 2008 (near the Lehman blow-up) to the second quarter of 2011, says the article. However, defaults have contributed 70-80% of the decline in mortgage and consumer credit. Of the mortgage defaults, it is estimated that up to 35% were due to ‘jingle mail’, as homeowners walked away from their ‘underwater’ homes and mailed the keys to the lenders.
Of course, just because household deleveraging may come to a halt in a few years, it does not mean that re-leveraging will kick into high gear. One wonders where any strong uptick in the borrowing power of consumers may come from, given the steep drop in home values and the relative lack of home equity borrowing availability.
We named this period of our economy as the “Greatest Deleveraging in the History of the World,” and discussed it at our Insurer Investment Forum in March, 2008. But, little did we know that it would be as virulent or spread to other countries, as it is in the process of doing in Europe.
And, we did not expect the unprecedented borrowing spree from the federal government, which amounted to the “Greatest Re-Leveraging”. However, if history of similar deleveraging incidents at other countries is a guide, we can expect the federal government to begin to show much lesser budget deficits as consumer deleveraging subsides and the economy begins a slow improvement. After all, consumers drive over two-thirds of US GDP.
As noted in several earlier blogs and confirmed by this latest research from McKinsey, this Deleveraging will take time (and now may even be impacted by a severe Deleveraging in Europe). But, at least it does appear we can see some light at the end of the tunnel.