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What Drives Consumer Debt Dynamics?

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What Drives Consumer Debt Dynamics? What Drives Consumer Debt Dynamics? By Edward S. Knotek II and John Carter Braxton onetary policy influences household spending through vari- ous channels. For example, low interest rates support higher Masset prices, increasing households’ wealth and producing more spending through the wealth effect. In addition, to the extent that previously acquired debts have floating interest rates or can be re- financed, low interest rates can reduce the burden of servicing those debts and free up cash flow for other spending. Low interest rates also tend to make new borrowing more attractive, which in turn can boost household spending. In the wake of the housing bubble, consumers generally have been reducing rather than increasing their debt levels despite low interest rates. Many policymakers and economists have pointed to this delever- aging process as an important drag in the subdued recovery from the financial crisis and recession. Deleveraging has entailed a combination of defaults by households, paying down of old debts, and weak borrow- ing to take on new debts. This article tracks the evolution of consumer debt by differentiat- ing between the number of consumers taking on more debt and the Edward S. Knotek II is a vice president and economist and John Carter Braxton is a research associate at the Federal Reserve Bank of Kansas City. This article is on the bank’s website at www.KansasCityFed.org. 31 32 FEDERAL RESERVE BANK OF KANSAS CITY dollar amount by which individual consumers are changing their debt levels. It shows that much deleveraging has occurred through a steep decline in the number of consumers taking on more debt. With rela- tively few borrowers taking advantage of historically low interest rates to take on more debt and expand spending, accommodative monetary policy is less effective than in normal times. While the number of consumers increasing their debt remains at low levels, it has recently begun to move higher. Consumers from lower-income areas and consumers with risk scores in the bottom half of the distribution—that is, individuals deemed to be relatively risky by a credit reporting agency—have been key drivers of this modest rebound. In addition, the number of consumers taking on more debt is growing across geographic regions, including areas that experienced strong debt growth during the housing bubble, suggesting that debt overhang is playing only a limited role in consumer debt dynamics in the recovery. The first section of this article describes the data used to study changes in consumer debt holdings. The second section examines recent changes in consumer debt in the aggregate. The third section shows how the percentage of consumers increasing their debt and the average size of debt changes drive aggregate debt movements. The fourth section shows how these two measures vary across different groups of consumers. I. DATA ON CONSUMER DEBT To study the evolution of consumer debt, this study relies on data on individual consumer debt holdings from the Federal Reserve Bank of New York’s Consumer Credit Panel (FRBNY-CCP). The FRBNY- CCP is a nationally representative sample of all individual credit re- cords maintained by Equifax, one of the major consumer credit re- porting agencies.1 The dataset begins in the first quarter of 1999 and includes detailed information on the amount of outstanding debt for an individual on a quarterly basis. The panel contains limited personal information, such as the individual’s year of birth and state, county, and zip code of residence.2 However, each quarter the panel provides the individual’s Equifax risk score.3 ECONOMIC REVIEW • FOURTH QUARTER 2012 33 This article breaks consumer debt into five categories: first mortgage, home equity, auto, credit card, and other.4 The analysis excludes student loan borrowing due to difficulties in matching borrowers over time. The combination of breadth and depth makes the FRBNY-CCP ideal for studying consumer debt dynamics. The representative nature of the FRBNY-CCP allows for computing aggregate debt statistics at the national level. At the individual level, the FRBNY-CCP employs unique identifiers so that individuals can be tracked over time and their borrowing histories reconstructed. Observing these borrowing histories can help determine which factors play an important role in driving the evolution of consumer debt.5 II. CONSUMER DELEVERAGING IN THE AGGREGATE Debt has been understudied in macroeconomics, due to the view that debt is simply a balance sheet entry: it is simultaneously one en- tity’s liability and another entity’s asset, which in the aggregate cancel each other. The financial crisis has called into question this view of debt and focused attention on how debt affects the economy. Growing consumer debt played a central role in fueling the recent U.S. housing bubble, and consumers generally have been reducing their debt in the aggregate since the height of the financial crisis in 2008 (Chart 1). Based on the FRBNY-CCP data, consumer debt excluding student loans peaked near $12 trillion in the third quarter of 2008. From the third quarter of 2008 through the second quarter of 2012, debt declined in each quarter, with the exception of the first quarter of 2011. The cumulative decrease in total consumer debt excluding stu- dent loans during this time was $1.6 trillion.6 Movements in housing debt have been key drivers of total consum- er debt. From the start of 1999 to the third quarter of 2008, total debt increased $7.5 trillion, with 89 percent of the increase accounted for by first mortgage and home equity borrowing. From the third quarter of 2008 to the second quarter of 2012, first mortgage debt decreased $1.0 trillion and home equity borrowing decreased $0.2 trillion, accounting for 78 percent of the decline in total debt excluding student loans. The trends in non-housing categories of debt have varied (Chart 2). Auto debt declined during the recession as light vehicle sales fell sharply, and both auto debt and vehicle sales have moved higher in Sources: Equifax, FRBNY-CCP, authors’ calculations. authors’ FRBNY-CCP, Equifax, Sources: theanalysis. from excluded Student loans are retail loans. debtincludesconsumerfinanceand Other Notes: Sources: Equifax, FRBNY-CCP, authors’ calculations. authors’ FRBNY-CCP, Equifax, Sources: includeshomeequityloansandlinesofcredit. equityborrowing Home Note: CONSUMER DEBT Chart 1 NON-HOUSING COMPONENTS OFCONSUMERDEBT NON-HOUSING COMPONENTS Chart 2 34 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 10 12 14 1 2 4 6 8 Trillions ofdollars 1999:Q1 1999:Q1 Trillions ofdollars 1999:Q3 1999:Q3 2000:Q1 First mortgage 2000:Q1 2000:Q3 2000:Q3 2001:Q1 2001:Q1 2001:Q3 2001:Q3 2002:Q1 2002:Q1 2002:Q3 2002:Q3 Home equityborrowing Credit card 2003:Q1 2003:Q1 2003:Q3 2003:Q3 2004:Q1 2004:Q1 FEDERAL RESERVE BANK OFKANSASCITY FEDERAL RESERVE 2004:Q3 2004:Q3 2005:Q1 2005:Q1 Other 2005:Q3 2005:Q3 2006:Q1 2006:Q1 2006:Q3 2006:Q3 Total debtexcludingstudentloans 2007:Q1 2007:Q1 Auto 2007:Q3 2007:Q3 2008:Q1 2008:Q1 2008:Q3 2008:Q3 2009:Q1 2009:Q1 2009:Q3 2009:Q3 2010:Q1 2010:Q1 2010:Q3 2010:Q3 2011:Q1 2011:Q1 2011:Q3 2011:Q3 2012:Q1 2012:Q1 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 2 4 6 8 10 12 14 ECONOMIC REVIEW • FOURTH QUARTER 2012 35 the recovery. Credit card debt peaked in the fourth quarter of 2008 and has yet to show signs of rebounding. Other debt—which includes consumer finance and retail loans—peaked in the early 2000s and has trended down since then. A number of recent studies have sought to quantify the impact of debt on economic activity. Several studies—such as Mian and Sufi (2010), Mian and others, and Dynan—document a connection be- tween leverage growth during the bubble and relatively poor economic performance during the downturn. Debt and borrowing are also key components of most recoveries. Past recoveries from recessions typically have been led by rising residen- tial investment and purchases of durable consumption goods, transac- tions that are financed by household borrowing. Accordingly, wide- spread deleveraging by consumers is cited as one factor impeding this typical cyclical pattern and accounting for the weakness of the recovery following the financial crisis. For example, Mian and Sufi (2011) sug- gest that high household debt built up in some counties during the boom led to weaker economic conditions in those counties in the early part of the recovery. In theory, deleveraging by some households need not be problem- atic for the economy if other, less-leveraged households step up their borrowing (Eggertsson and Krugman; Hall). However, the persistent declines in aggregate household debt imply that this process has not occurred in the current recovery. One reason less-leveraged households have not stepped up their borrowing is the zero lower bound on interest rates. Under normal con- ditions, if borrowers grow more cautious and borrow less at a given interest rate, borrowing demand falls and market forces cause interest rates to decline. Monetary policymakers also can intervene to lower in- terest rates. In both cases, the lower rates act as an offset to the increased caution and stimulate borrowing activity. In current circumstances, however, many short-term interest rates have fallen essentially to zero and cannot go lower. Thus, neither policymakers nor market forces have been able to push rates low enough to offset the shocks buffeting the economy, such as an increase in caution on the part of borrowers that has reduced demand. 36 FEDERAL RESERVE BANK OF KANSAS CITY Indeed, weak demand for borrowing, especially for new mortgage debt, appears to account for a considerable portion of declines in con- sumer debt, even though defaults on previously issued mortgage debt remain at elevated levels (Bhutta; Haughwout and others).
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