Tuesday, 23 September 2008

The crushing truth about US household debt

I always feel guilty posting stuff about the US economy. This blog is supposedly devoted to our own bubble-related difficulties here in the UK. However, events on the other side the Atlantic are too frightening to ignore. I reckon it is where we are heading, so we should pay attention.

Here are two charts that illustrate how debt has squeezed US households. The first chart illustrates total household financial obligations as a percent of disposible income. In other words, it measures how much households are paying in interest and principal as a percent of their post tax income. The answer is about 20 percent - one dollar in five heads over to the bank.

As you would imagine, the bulk of payments go in interest charges. This is a huge transfer of wealth from the indebted masses to a tiny number of bloated overpaid bankers. This is what accounts for growing income inequality in the US.

You will notice that both charts tick down slightly in 2008. That is Bernanke's panic attack, when he reduced rates to just 2 percent. Notice how little the impact was on the household debt servicing burden. So when you hear people talking about rate cuts, remember the US example. Rate cuts don't help. Either banks don't pass on the reductions or people use the lower rates to build up ever higher debt levels.

12 comments:

will said...

"Rate cuts don't help. Either banks don't pass on the reductions or people use the lower rates to build up ever higher debt levels."

Surely the fact that the 'obligations' ticks down at the same time points to the former rather than the latter? Or have I misread something?

Like the blog, anyway - always so cheering.

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Alice Cook said...

Will,

Yes, it does tick down, but you have to remember the magnitude of the cuts relative to the minimal size of the reduction.

Hence, rate cuts don't help.

Alice

dearieme said...

If rate cuts don't help, does that mean that rate rises won't hinder?

Anonymous said...

"If rate cuts don't help, does that mean that rate rises won't hinder?"

Rate rises cut debt and the service of debt, but a lot of it is via bankruptcy - which is possibly not the mechanism you were looking for.

If you want to bring it down gradually, then raise reserve requirements.

Anonymous said...

Alice - why don't you graph the UK data and compare and contrast?

It might be the same, or totally different. Would be nice to know if we're going to hell in a hand-basket, or in a wally trolley...

Anonymous said...

"This is a huge transfer of wealth from the indebted masses to a tiny number of bloated overpaid bankers. This is what accounts for growing income inequality in the US"

No one forced the fools to borrow.

Nick

Anonymous said...

By putting interest rates below the rate of inflation, the Fed penalised saving.

How much of a financial penalty does that have to be before it constitutes "forcing"?

apscomp said...

In addition to that, most of the debt, which is in the form of mortgages, are based on LIBOR, of UK.... , not the Federal Funds rate of USA....

dearieme said...

"How much of a financial penalty does that have to be before it constitutes "forcing"?" Financial penalties never equal a bayonet in the back. Talk of "forcing" is just an attempt to avoid admitting responsibility. No doubt bankers say that competition "forced" them to take silly risks. It's the same lie.

Anonymous said...

Existing debt is at a previously set rate. so cutting shouldn't cause a drop. It should slow growth of new debt which is why you see only a small dip.

will said...

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