Summary: FRBSF Economic Letter Global Household Leverage, House Prices & Consumption
(1) In this paper, the authors point out that the countries with the largest increases in household leverage, which is measured by the ratio of debt to personal income, during the 10 years leading to 2007, tended to experience the fastest rises in house prices during the same period. Furthermore, as household prices began to fall, these countries also had a tendency to experience the largest declines in household consumption.
(2) U.S. household leverage achieved a record level in 2007 when it exceeded 130%. The deleveraging process can occur through: (a) increased household savings; and (b) increased default rates. Both processes could significantly constrain future consumption and bank lending, thus slowing the economic recovery.
(3) During the 10-year period, in the U.S., real house prices increased by roughly 50% and peaked in 2006. Housing prices rose noticeably faster in those areas where subprime mortgages were more concentrated.
(4) The magnitude of a recession of each country tends to be correlated with the amount of the prior growth that was fueled by increased unsustainable borrowing.
(5) Conclusion:
“Real house prices in the US rose nearly 50%, reaching a peak in 2006. These run-ups in housing far exceeded the growth in disposable incomes over the same period of time. Going forward, the efforts of households in many countries to reduce their elevated debt loads via increased saving could result in sluggish recoveries of consumer spending. Higher saving rates and correspondingly lower rates of domestic consumption growth would mean that a larger share of GDP growth would need to come from business investment, net exports, or government spending. Debt reduction might also be accomplished via various forms of default, such as real estate short sales,foreclosures, and bankruptcies. But such deleveraging involves significant costs for consumers, including tax liabilities on forgiven debt, legal fees, and lower credit scores.”
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Tagged with Consumption, Default Rate, Deleverage, Federal Reserve Bank of San Fransico, Global Household Leverage, House Prices, Household Savings, Recovery, Subprime
