On the Household Debt Problem

One of the not so frequently discussed problems with the economy is the household debt problem. Debt-to-income ratios spiked in the past decade, and the weight of household debt has had far ranging implications—from challenges in selling homes to the wave of strategic defaults and walk-aways to the impact deleveraging has on reduced consumption and savings.

Household debt isn’t the only problem holding back the economy. Some banks don’t want to lend, and many businesses don’t want to borrow. Financial regulations have measurably slowed down economic activity. Unknowns in taxes certainly have stalled a healthy measure of entrepreneurism (though there is no guarantee those initiatives would have worked out). So it is a mixed bag, but household debt is a key.

One way to show that household debt really is a problem for the economy is to look at the county level data, which economists Atif Mian and Amir Sufi did earlier this week. Using the variation in household debt growth across U.S. counties from 2002 to 2006, they examined the effect of high debt on residential investment, durable consumption, and employment during the recovery and found,

counties with high household debt experienced relatively high employment declines well before the recession began. During the most severe part of the recession, employment losses in high household debt counties were dramatic. Total employment declined by 7% from the second quarter of 2008 to the second quarter of 2009. Furthermore, employment remained at extremely depressed levels in high household debt counties through the second quarter of 2010. By contrast, employment growth in low household debt counties stabilized as early as the second quarter of 2009. Total job losses were much lower. While there is still no evidence of robust recovery in low household debt counties, the employment situation is far less bleak than in high household debt counties.

The nearby graph from the Mian & Sufi paper illustrates this phenomenon well. The authors conclude, “It is likely that the large increase in debt burdens had both a direct effect on the economy and an indirect effect due to the subsequent sharp declines in house prices in highly leveraged areas.”

The study also notes that the evidence at the county level “strongly suggests that credit demand is weak because of an over-leveraged household sector. This view is supported by survey evidence that the main worry of businesses is sales, not financing.”

See the whole economics letter from Mian & Sufi here.