Stick It: Consumers Default on $822 Billion in Debt

Dare we propose that consumers have learned a thing or two from their banking breathren? Just as the financial services industry understands that governments will bail them out if their risk management systems fail, so consumers appear to have decided that what works for the bankers, works for them. They have defaulted on close to $1 trillion in mortgage, credit card and other forms of consumer debt in the past two and a half years. Has this imposed some market-based discipline on the system or is it a giant game of chicken?

David Wessel shares his observations in the Wall Street Journal:

"$822 billion: the amount defaults have lopped off U.S. household debt since mid-2008.

U.S. consumers deserve some credit for getting their debts under control. But they still have a way to go.

One of the puzzles of the recovery has been how U.S. households have managed to shed some $658 billion in mortgage, credit-card and other consumer debt over the past two and a half years: Are they really paying it down, or are they just giving up and defaulting? The answer would say a lot about their ability to fuel an economic recovery, and help gauge the likelihood that they’ll get into trouble again.

The latest data from the Federal Reserve suggest defaults have played a big enough role that “paying down” would be a misnomer. By our own estimate, based on the Fed data, banks’ and investors’ charge-offs — the result of defaults — lopped $822 billion off households’ debt load from mid-2008 to the end of 2010. In other words, net of defaults, consumers actually borrowed an added $163 billion.

That calculation alone, though, doesn’t provide a full picture of consumers’ change in behavior. They may be adding debt, but they’re doing so at a much slower pace than during the housing and credit boom. Net of defaults, household debt grew at an average annualized rate of only about 0.5% from mid-2008 to the end of 2010. That compares to about 10.5% in the preceding decade, a difference of 10 percentage points.

Weighed against defaults, consumers’ relative frugality accounts for the lion’s share of the change in their debt position. From mid-2008 to the end of 2010, their combined debts fell at an average annualized rate of about 2%, compared to an average annualized rise of nearly 10% in the preceding decade — a difference of almost 12 percentage points. So the slowdown in borrowing accounts for more than 80% of the shift.

Lately, though, consumers’ vigilance appears to be easing as banks’ willingness to lend returns.Household debt growth, net of defaults, has stopped slowing, and the latest monthly data suggest it might accelerate again. That could be good for economic growth in the short term. But it would leave household debt at about 116% of annual disposable income — still much higher than the 100% level economists tend to consider bearable in the long term. Unless, of course, defaults keep grinding the debt down