Household Debt

Household debt has a significant impact on the U.S. economy since 70% of U.S. economic production comes from consumer spending. During economic recessions, consumers tend to pay off their credit cards, reduce spending, and increase savings. The Credit Crisis had a wrenching impact on U.S. households resulting in significant deleveraging. Household debt, as a percent of household disposable income, is at its lowest level since 1980. American household balance sheets are healthier than they have been for a generation.

Corporate Debt

Financial and non-financial firms use debt in different ways. For a financial firm, such as a bank, debt is a direct source of capital that can be used to generate revenue through lending. For a non-financial firm, debt is used to purchase capital assets which are then used to produce goods that can be sold to generate revenue. In 1980, financial firms accounted for 12% of total corporate profits. As of the first quarter of 2019, they account for 20%. From 1980 through the end of the Credit Crisis, securitization catalyzed a process called financialization where financial assets, like mortgages, were moved from banking systems, where they were tightly regulated, to the capital markets where they are poorly understood. Financialization was a primary cause for increased debt in financial companies.

On a company-by-company basis, leverage can be measured using financial ratios like debt-to-assets. When assessing aggregate corporate leverage, it is common to look at corporate debtto-GDP. As the graph on the next page illustrates, after each recessionary period, there is a pause and then a burst of leverage. Lower interest rates, which have been a trend since the early 1980s, have pushed financial managers to increase the proportion of debt in their capital structures. However, as the graph below illustrates, something happened in 2008-09, during the Credit Crisis, that reversed the trend of increased leverage.

Since the Credit Crisis, U.S. corporate balance sheets appear to have embarked on a pattern of deleveraging. To better understand this pattern, we need to separate the corporate sector into financial and non-financial companies. The following graph charts U.S. financial company debt as a percent of gross domestic product. While it shares the general deleveraging shape and trend of the total corporate graph above, the acceleration of indebtedness among financial firms, which is almost exclusively related to the advent of financial securitization which began in earnest in 1989, seems almost devoid of the plateaus indicative of normal business cycles. The period of deleveraging following the Credit Crisis, coincides with a significant reduction in the securitization market and the balance sheet stress related to securitization.

With financial companies removed, the cyclical impact of business cycles on non-financial balance sheets is much more apparent. The graph on the following page clearly shows that peak balance sheet leverage-to-GDP ratios coincide with recessionary periods, at least over the last three economic cycles. Some caution is warranted here. What companies do with the debt matters. During the recession of 1980, corporate debt was mostly traditional and economic cycles of boom and bust were the result of overbuilding capacity, funded by debt. During the internet boom, debt was used to acquire companies with spurious economic viability. More recently, leading into the Credit Crisis, increased indebtedness fed a real estate market on steroids. In each of these three economic cycles, increased leverage was used to fund non-performing assets. The current run of non-financial corporate indebtedness is being used to fund share buy-backs which are, by their nature, existing and performing assets.

Government Debt

Most governments around the world have been on a borrowing spree over the past decade. Initially, increased government indebtedness was blamed on the need for government intervention following the Credit Crisis. But since then, increased deficit spending has forced governments to continually increase their debt. It is common to measure national government debt by comparing it to the country's gross domestic product. A comparison of countries below shows some real outliers. The debt numbers included in this analysis only include explicit indebtedness. Social Security, Medicare, Medicaid, and unfunded pension liabilities are not included.

Governments pay debt service using tax receipts. Consequently, comparing the U.S. government's debt burden to its tax receipts can be a useful measure to understand its current level of indebtedness. Forty years ago, in 1980, the U.S. government's debt was 2.58 times its tax receipts. Today, the same ratio is 10.91. The take home lesson for the United States is that the burden of government services currently being provided to its citizens is being shifted to another generation through increased indebtedness.

rg L.P. 9.5% 10.0% 10.5% 11.0% 11.5% 12.0% 12.5% 13.0% 13.5% Mar -80 Mar-82 Mar-84 Mar-86 Mar-88 Shaded Areas Are Recessions Disposable Income Mar-90 Mar-92 Mar-94 Mar-96 Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 US Household Debt as a Percent of Household Mar -08 Mar-10 Mar -12 Mar-14 Mar-16 Mar-18-10.0% -5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% Mar-80 Profits Mar -82 Mar-84 Mar-86 Mar-88 Mar-90 Mar-92 Mar-94 Mar-96 Shaded Areas Are Recessions Mar-98 Mar-00 Mar-02 Mar- 04 Mar-06 Finance Profits as a Percent of Total Corporate Mar-08 Mar-10 Mar-12 Mar-14 Mar-16 Mar-180% 20% 40% 60% 80% 100% 120% 140% Mar-80 Mar-82 Mar -84 Mar- 86 Mar-88 Mar-90 Mar-92 Mar -94 Mar- 96 Shaded Areas Are Recessions Mar- 98 Financial Corporate Debt-to-GDP Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 d the balance sheet stress related to securitization. Mar-16 Mar-18 US. Government Debt Divided by Tax Receipts Shaded Areas Are Recessions 120 10.0 8.0 6.0