Last week the New York Federal Reserve released their quarterly report on US ‘Household Debt and Credit’. US household debt rose to $12.58tn, with increases in credit card, auto, student and housing loans. This represented a 1.8% increase from the previous quarter and after gradually rising over recent years is now back to 2008 levels in absolute terms. In 2016 US households borrowed a further $460bn in aggregate. On its own this figure is hardly a warning signal, especially as household debts as a percentage of GDP remain well below the ~90% levels of 2008. Nevertheless if a string of related indicators show persistent worsening, the housing and household sector could originate a broader risk-off environment in the US and globally.
The US housing market is a $26tn asset class, larger than the US stock market. Whereas the stock market and certain property hotspots have rallied in recent years, US house prices on average have stalled for the past 3 years. Alongside the rise in overall household debts, it’s worth noting that mortgage delinquencies also spiked up dramatically at the end of 2016 after six years of steady decline (mortgage delinquencies and defaults continued to rise for a couple of years following the Global Financial Crisis). These were a leading indicator of the 2008 market crash and were trending upwards from early 2006. In the 4th quarter of 2016 US prime mortgage delinquencies jumped from 2.6% to 3.1% of loans.
Since the peak of 7.3% in early 2010 there have only been a couple of modest single-quarter spikes in delinquencies, none as large as the latest, and all reverting downwards again in the following quarter. Given that we are close to recent historical average levels (~2.5% in the decade preceding the crisis) this may just be a fluctuation and future readings will not drift that far from current levels. But given the high levels of total household debt and the expected rise in rates and potential living costs it is also possible that we will see more households struggling to make mortgage payments on-time (even if these don’t rise due to typically fixed rates). Given the relatively strong US employment and economic data, and that it was only 4 quarters since the US Federal Reserve first raised rates (after 7 years at 0-0.25% and only a modest rise to an upper bound of 1%), if these struggling payments are a result of these tighter conditions then this sensitivity of household debts could slow the Fed’s path to normalisation.
Some assessments of country debt profiles focus too much on government debt and fail to properly account for the overall Net Foreign Debts of a country (including household and corporate debts). For example, considering Japanese large government debts whilst not properly accounting for household savings in Japan can give the false impression that the country is a net debtor: which it is not. Or not fully factoring banking sector debts in countries such as Ireland missed the contagion risks when those debts were suddenly assumed by the government following the GFC. We continue to commend a Net Foreign Asset baseline approach to reviewing countries debt profiles: working from this to considering the risks of each sector's debt profile.
When a country is a net creditor (or low level net debtor), even if one sector is heavily indebted, it is effectively domestically owed and so is typically less risky and more manageable (compare Japan’s debts to Greece’s for example). When a country has large net foreign debts often multiple sectors (public, corporate and household) are excessively indebted: and this to foreign bodies. These are more difficult to manage and can quickly become unmanageable. The US is actually only a modest net foreign debtor (3 Star according to our NFA analysis) despite having public debts approaching $20tn and household debt approaching $13tn. The US private sector is, on the whole, not heavily indebted; and although the US government is, they have a privileged position in international markets and for now only truly at risk from their own Congress’ brinkmanship. Household debts and financial entities exposed to them (including mortgage debts not guaranteed by the government) are potentially the more poignant risk to be monitored here. Assessing these alongside household and business lending conditions forms only part of our top-down analysis, but one that may become more relevant in coming quarters.