PensionReforms' summary and comments
This 2007 report on US household debt was published just as the global economic crisis was getting properly under way.  By the report's publication, there had been a "dramatic deterioration in the performance of subprime variable-rate mortgages".  The report looked at why household debt had risen so much in recent years; from an average of 60% of aggregate personal incomes in the 1980s to 100% in the 1990s.

The report relies on data from the Survey of Consumer Finances gathered at three yearly intervals between 1983 and 2004.  On balance, the report thought that the large increase in debt was explainable and of not that much regulatory concern:
 "The debt of U.S. households has risen very substantially relative to income, especially in the past five years or so.  This increase mainly reflects the efforts of households to smooth consumption over time in response to shifting perceptions about future income, wealth, and interest rates, along with the effects of financial innovation that has reduced constraints on the ability of households to realize desired consumption patterns."

The report suggested that households seemed not to have been overdoing things.  They seemed not to be more "impatient";  nor ".did we unearth strong evidence of reduced risk aversion or perceived risk as a motive for borrowing and spending more now instead of saving."

It also seemed that, while households seemed to need lower 'precautionary' savings, that seemed to account for only a small part of the overall trends in debt accumulation.  Of greater significance seemed to be the ageing of the population.

"Demographics have probably contributed to greater indebtedness, through both the greater concentration now of baby boomers in the part of the lifecycle where debt use is highest and the increases in educational attainment, likely a proxy for higher lifetime earnings as well as more-sophisticated use of financial instruments."

The long term reduction in the cost of debt ".may have also boosted debt to some extent."

Had incomes grown, we might have expected increase in overall debt levels as the ability to service loans grew.  But ".median real incomes have not grown very rapidly in recent years, and survey responses suggest that households have not been very optimistic about their earnings in the immediate future over the past several years, when the growth in debt has been especially strong."

PensionReforms observes that events subsequent to the report suggest that US consumers were right not to be optimistic.

"The most important factors behind the rise in debt and the associated decline in saving out of current income have probably been the combination of increasing house prices and financial innovation."

There are now more ways of raising debt and at lower cost.

"One implication of this analysis is that a portion of the rise in debt relative to income probably reflects a shift in the level of spending that is not likely to be repeated unless house prices continue to increase as quickly as in the past and financial innovation continues to erode cost and availability constraints at a rapid pace."

In summary, the authors conclude that there did not seem then to be too much to worry about.  The increased innovation and ".the increase in access to credit and levels of assets over time should give households, on average, a greater ability to smooth through any shocks."

However, the group of households with a large amount of debt relative to assets is more vulnerable.  Those households may have what the report calls "unreasonable expectations about future income or asset appreciation".  "Although these households represent a relatively small share of the population, in some circumstances such developments could have effects large enough to show through to the macroeconomy."

PensionReforms notes that was then.  The global economic crisis has exposed some of the conclusions.  For example, US house prices have fallen since their peak in the second quarter of 2006.  According to the S&P case-Shiller Index (see here, the fall in the subsequent three years to 2009 across the US as a whole was 41%.

The apparently "improved assessment and pricing of risk" now seems to have been illusory.  And the "expanded lending to households without strong collateral; and more widespread securitisation of loans, which has likely lowered the cost of credit" are now widely seen to have contributed to the crisis.  It is, however, very easy to be wise after the event.  (File size 148 KB; 45 pp) 379