The Long Slog of Paring Debt - The U.S. went on a borrowing binge in the 2000s and is now in the deleveraging phase.
Economists describe the economy in equations. Columnists prefer metaphors.
In physics, leverage is the factor by which a lever multiplies force. In finance, leverage allows the bold to borrow to make bets today that are supposed to pay off later. But leverage magnifies losses when things go bad. Borrowing binges are followed by spells of deleveraging in which lenders, investors and consumers borrow less, save more and take fewer risks.
The U.S. went on a borrowing binge in the 2000s and is now in the deleveraging phase. To borrow a metaphor from Federal Reserve Chairman Ben Bernanke, this is creating "formidable headwinds" that are blowing against the economy's natural momentum and fiscal and monetary policies aimed at increasing it.
One more metaphor: Think of deleveraging as a four-quarter American football game. Which quarter are we in? The question matters. Until the deleveraging game ends, the economy can't fully recover. In answering it, one quickly realizes that more than one game is under way.
For big companies outside the financial industry, the game is finished. This time, they didn't overdo the borrowing; indeed, they're flush with cash.
U.S. banks are well along. Prodded by regulators, they have raised capital, one form of reducing leverage. A couple of big ones—Citigroup and Bank of America—have been selling assets, another way to delever. Nearly every Federal Deposit Insurance Corp. measure shows U.S. banks have bigger capital cushions and less leverage than they did before the crisis. U.S. banks are no longer tightening lending standards. Put them in the fourth quarter of deleveraging; that's good.
Their European counterparts are still in the first quarter, maybe even at the kickoff; that's not good. They haven't fully acknowledged likely losses on some of their holdings of euro-zone bonds. They haven't recapitalized. And they are still tightening lending standards.
For American households, it is—at best—halftime. Americans are saving more. They're either unable or unwilling to borrow as they pay off (or walk away from) their debts. Measured against after-tax income, household debt began soaring in the late 1990s, peaked in 2009 and has fallen since—but only to 2004 levels. No one knows how much further Americans want to go, but it's likely to take them a long time to get wherever they are going.
"Unlike banks," says David Scharfstein, a Harvard University economist, "households can't raise equity capital to pay down debt. So the only way to get deleveraging is house-price appreciation (which hasn't happened), debt writedowns/ modifications (some), or foreclosures/short sales (some)."
He points to the mortgage-debt burden—and winces. Until the late 1990s, the sum of all American mortgages was about 40% of the value of the underlying homes. Americans borrowed heavily against their houses, and then house prices fell. By this metric, the debt burden rose to about 62%—and hasn't yet come down. (This is an average, of course. Some people have no mortgage debt. About one in five homeowners with a mortgage owes more than 100% of the current value of the house.)
While banks and consumers have been deleveraging, the government has been doing the opposite. Measured against the size of the economy, federal debt is at highs not seen since World War II. In part, that's by design: The plan was for the government to borrow more for a time to cushion the effects on the economy of bank and household deleveraging. For government deleveraging, it's still the first quarter.
Right now, the federal government is able to borrow at extraordinarily low interest rates, but that won't last forever. Politicians admit that. But despite the talk, they aren't close to agreeing on the curbs on health and other benefit spending and tax increases that are inevitable.
Add it up: U.S. bank deleveraging is in the fourth quarter, but European banks are in the first. Overall U.S. consumer deleveraging is at halftime, with housing still in the first quarter. Government deleveraging has barely begun. This will hold back economic growth for a long time.