The Great Deleveraging Lie

You can't open a newspaper or watch a business news network without learning that consumers and businesses have been deleveraging. The storyline is that consumers and corporations have seen the light and are paying off debts and living within their means. Austerity has supposedly broken out across the land. Bloomberg for example, peddled this storyline last week:
 

US Household Debt Shrank 1.5% in the Second Quarter

American households pared their debts last quarter, closing credit card accounts and taking out fewer mortgages as unemployment persisted near a 26-year high, a survey by the Federal Reserve Bank of New York showed Consumer indebtedness totaled $11.7 trillion at the end of June, a decline of 1.5% from the previous three months and down 6.5% from its peak in the third quarter of 2008, according to the New York Fed's first quarterly report on household debt and credit. The report reinforces forecasts for a slowing economy in the second half of 2010 as consumers hold back on spending and rebuild savings.

You have to wonder whether the pundits and mainstream media actually believe what they're saying, or whether this is a concerted effort to convince the masses that they've done enough and should start spending. Consumer spending as a percentage of GDP is still above 70%. This is well above the 64% level that was consistent between 1950 and 1980. Consumer spending has been entirely propped up by an ever increasing level of debt.

The American economy will never recover until consumer spending drops back to the 64% range that indicates a balanced economic system. For the mathematically challenged, this means that consumers need to reduce their spending by an additional $850 billion per year. Great news for the 1.5 million retailers in America.

Below is a chart that shows total credit market debt as a percentage of GDP. This chart captures all of the debt in the United States carried by households, corporations, and the government. The data can be found here.

Total credit market debt peaked at $52.9 trillion in the first quarter of 2009. It's currently at $52.1 trillion. The "great de-leveraging" of the United States has chopped our total debt by 1.5%. Move along. Nothing to see here. Time to go to the mall. Can anyone in their right mind look at this chart and think this financial crisis is over?



During the Great Depression of the 1930s, total credit market debt as a percentage of GDP peaked at 260% of GDP. As of today, it stands at 360% of GDP. The federal government is adding $4 billion per day to the national debt. GDP is stagnant and likely won't grow for the next year. The storyline about corporate America being flush with cash is false; corporations have added $482 billion of debt since 2007. Corporate America actually has the largest amount of debt on the books in history at $7.2 trillion.

Now we get to the fallacy of frugal consumers paying off debts, cutting up those credit cards, and eating Ramen noodles five nights a week. Household and non-profit debt -- which includes mortgages, credit card debt, auto loans, home equity loans, and student loans -- peaked at $13.8 trillion in 2008. After two years of supposed deleveraging, frugality, and mass austerity, the balance is $13.5 trillion. Consumers have buckled down and have paid off 2.2% of their debts, it seems. Not exactly going cold turkey, but it's a start.

But wait. Consumer debt outstanding is $300 billion lower. If you hadn't noticed, the banks in the United States have been taking a few losses on their loans over the last couple years. A simple search of the Federal Reserve website reveals that banks have charged off 5.66% of all their loans in the last two years. The charge-off rate in the second quarter of 2010 was 6.66%. (Click here to verify this for yourself.)

So, let's get down to the nitty gritty. If consumer debt was $13.8 trillion at the end of 2008 and the banks have since written off 5.66% of that debt, total write-offs were $800 billion. If total consumer debt now sits at $13.5 trillion, then consumers have actually taken on $500 billion of additional debt since the end of 2008; consumers haven't cut back at all. They're still spending and borrowing. It's beyond my comprehension that no pundits or mainstream media outlets can do the simple math to realize that this deleveraging story is a fairy tale.

The truth is that the debt has simply been shifted from criminal Wall Street banks to the American taxpayer. These consumer debts were created in a private transaction between individuals and these banks. When the loans went bad, consumers should have lost their homes, cars, etc., and their credit ratings should have been ruined, keeping them out of the credit market for a number of years. If the banks that made these bad loans made too many, they should have failed and had their assets liquidated in bankruptcy. Instead, the federal government has inserted the American taxpayer into the equation by using our tax dollars to prop up insolvent Wall Street banks and allowing people who took on too much debt to live in houses for over two years without making a mortgage payment.

The Big Lie will eventually lose out to the grim truth. America's economy is built on a debt-based foundation of sand and the tide of reality is relentlessly eating away at that foundation of debt. Collapse is just a matter of time. The charts below from the Federal Reserve paint a grim picture of reality.

Total Debt Balance and Its Composition



Total Balance by Delinquency Status



New Seriously Delinquent Balances by Loan Type