US consumer debt: Another case of complacency
23 May 2002
In my article on 20 May, I had commented that Bloomberg columnist Caroline Baum appeared overly optimistic regarding the US dollar, ignoring potential risks to the currency. Dr. Irwin Kellner, chief economist for CBS.MarketWatch.com, appears to exhibit another case of complacency in a recent article, this time over US consumer debt.
"The growing concern that the consumer is becoming an irrational borrower is misplaced," he writes in the article published on 21 May. "People are borrowing for the right reasons - and their debt loads are not as high as they seem."
"By some measures, total consumer debt outstanding now exceeds total household incomes," he admits. But he goes on to add: "However, when you compare household debt to the value of people's assets, things don't look quite as scary. The value of stockholdings may be down - but real estate values are soaring. And for most people, their home is their biggest asset."
"Moreover, a large chunk of the debt that people are taking on these days is mortgage debt. This reflects the powerful combination of rising home prices and low mortgage interest rates."
Unfortunately, soaring asset values that increase the availability of credit which in turn feeds further demand for the asset is exactly how financial bubbles form. It looks like a virtuous circle on the way up, but becomes a vicious circle on the way down.
Kellner says that "households are investing their money in an asset whose value is rising - exactly what the textbooks say they should do." To be more precise, the textbooks say that money ought to be invested in undervalued assets whose values are rising. Investing in overvalued assets using credit just to take part in a rising market is a financial bubble.
But is real estate overvalued? Kellner himself writes: "It takes more years of the average family's income to buy the average home today than at any time in the past 20 years." This tells you that homes are becoming less affordable, and leads to the question of whether further price rises are likely. Bear in mind, too, that unlike the 1970s, real estate prices have been rising recently at a time of general disinflation.
This is not to say that the real estate boom in the US is necessarily a bubble about to burst. However, it does mean that US debt levels need to be watched closely. The repeated doses of cheap credit administered by the US Federal Reserve since the 1990s have created a situation in which the US economy is practically dependent on high debt levels, and could face a crisis should the debt start to unwind.
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