Deleveraging For All. Almost.

Jan 25, 2012 by

You’ve likely seen or heard the words “deleveraging,” or “delevering,” in financially oriented media. Using big words and esoteric terms is popular among workers in industries with little real value to add, and these terms made Wall Street-types still sound smart—or so they thought—in the aftermath of the 2008 meltdown when everyone was thinking Wall Street-types were pretty dumb. Since we’re all catching on now to the term, its marketing value has subsided, and I hear it less often.

What’s “Deleveraging”?

“Deleveraging,” sometimes pushed to “delevering” by those really frantic to impress, simply refers to the process of cutting debt.

A recently released report by McKinsey Global Institute (which does have real value to add) analyzes the ongoing develeraging process, providing data on the ten largest developed economies with special focus on the U.S., U.K., and Spain. There’s a lot of interesting stuff in the report, but here’s once excerpt that summarizes U.S. deleveraging over the past three years:

“Since the end of 2008, all categories of US private-sector debt have fallen relative to GDP. Financial-sector debt has declined from $8 trillion to $6.1 trillion and stands at 40 percent of GDP, the same as in 2000. Nonfinancial corporations have also reduced their debt relative to GDP, and US household debt has fallen by $584 billion, or a 15 percentage-point reduction relative to disposable income. Two-thirds of household debt reduction is due to defaults on home loans and consumer debt. With $254 billion of mortgages still in the foreclosure pipeline, the United States could see several more percentage points of household deleveraging in the months and years ahead as the foreclosure process continues.”

And you know how I like graphs:

Here we see household, government, financial sector (e.g., banks, insurance companies), and non-financial corporate debt as a percentage of GDP (Gross Domestic Product—the total value of the country’s economic output). Total consumer debt has dropped from nearly equal to GDP to about 86% of GDP. Only government—hit by the triple whammy of bail-outs, stimulus programs, and tax collection slashed by the recession—has grown its debt.

New Commitment to Living Within One’s Means?

Some get all gooey, observing such data, warmed by U.S. consumers’ new found commitment to paying off debt, reducing consumption, and living frugally again. I’ve been a bit skeptical that Americans collectively turned over a new leaf just because of one little ol’ meltdown; turns out my instinct may be right.

As the report excerpt above says, two-thirds of the 2008–Q2 2011 drop in household debt was due to defaults. I suspect—but admittedly don’t have data—that a big chunk of the remaining one-third decline is due to contracting credit availability: Tighter mortgage lending standards, reduced credit card limits, zapping of credit lines, and the like.

I’m not convinced financial institutions have turned over a new leaf either. The report says that $1 trillion of the debt decline in that sector is due to 2008 Wall Street carnage: the collapse of Lehman Brothers, JP Morgan’s purchase of Bear Sterns, and the Bank of America/Merrill Lynch merger. To be fair, McKinsey also says, qualitatively, that “[s]ince 2008, banks also have been funding themselves with more deposits and less debt.”

I’m not sure any of the tough lessons of the housing and credit bubble and the ensuing 2008 meltdown have stuck and changed behavior. Have you seen evidence of widespread, voluntary changes in habits—whether among individuals, corporations, or governments—that may reveal heightened resolve to take less risk and solidify financial foundations?

Do you have a deleveraging story? And was your deleveraging forced (your bank unilaterally closed your home equity line of credit, for example) or voluntary?

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