Household leverage: US vs. UK
Households in the US and the UK are members of the “most levered club”. But put their balance sheets side-by-side, and the outlook for the US economy looks a little brighter than that for the UK. Why? Both are dropping debt burden, but a qualitative analysis suggests that the UK household leverage (probably) should be falling at a more accelerated pace.
The chart illustrates leverage in the US and UK, or household debt (loans) as a percentage of disposable income (DPI) through Q3 2009 and Q2 2009, respectively (the UK releases Q3 Economic Accounts at the end of December). By Q2 2009, UK and US households dropped leverage rather coincidentally, -4.8% and -4.4%, respectively. However, the debt bubble was bigger in the UK than in the US, peaking at 160% of DPI compared to 131% in the US. Why isn’t leverage falling more quickly? Spending.
To be fair, UK Q3 statistics may paint a very different picture. However, that is unlikely, given that real retail sales continue to grow, 3.2% at an annualized rate in the three months ending in October.
Oh, it all makes sense now: UK retail sales remained firm in 2009, and real home values hit a (probably local rather than global) cyclical low much earlier than in the US.
This is an ominous sign for the UK economy. Households are kicking the can down the road: de-leveraging – paying down debt by dropping consumption and saving a relatively higher share of income – is inevitable.
Rebecca
Hmmm. Some aspect of all this fancy technology seems to have turned my clipboard off … no matter … And I don’t have a cursor here in this comment box Oh well, cursors are for wimps.
Anyway. you asked why leverage isn’t falling faster. Two things to think about.
1. Strictly speaking, your leverage metric has dimensions of debt/disposable income = currency/(currency/time) which would seem say that the units of the vertical axis are years. The metric seems plausible, but perhaps it really isn’t
2. Shouldn’t we really be interested in the ratio of debt to disposable income relative to some optimum value rather than to each other?
In any case, unless the marketplaces are rebubbled, I don’t see that either the US or UK economies are deleveraging at anything like the rate they need to in order to bring things into some sort of balance. At least not for a number of years. But what do I know?
Hi VtCodger,
<Shouldn’t we really be interested in the ratio of debt to disposable income relative to some optimum value rather than to each other? >
I couldn’t agree more. This is purely a qualitative approach. People (can’t name who they are at this moment in time) suggest that a 100% debt/DPI ratio is some sacrosanct measure of equilibrium (see for example, this article at the San Francisco Fed) – but it’s not. Households across economies have very different levels of optimal debt leverage based on a number of factors, including level income, preferences, and risk aversion to name a few. I’ve been thinking about ways to estimate and/or quantitatively suggest optimal levels of debt but have come up dry. Any ideas?
By the way, I have a cursor.
Rebecca
It would be interesting to look at debt service ratios as well as debt magnitude. Most debt in the UK is floating rate and debt service has fallen along with rates, what is interesting is that despite this UK households a paying down debt. I don’t know enough about the relative circumtstances to compare the economies in detail; the US is clearly on a suicide path but we could well beat them to it.
It will be interesting to see how these differences between the U. S. and the U. K. play out. 🙂
***couldn’t agree more. This is purely a qualitative approach. People (can’t name who they are at this moment in time) suggest that a 100% debt/DPI ratio is some sacrosanct measure of equilibrium***
If memory serves, the ratio was very stable at 80% from the 1950s until the World was cursed with those twin twits Reagan and Tatcher around 1980. Or maybe that was some other metrric.
On other quibble is that leverage is probably better taken as the sum of public and private debt to GDP. At the moment, the US private debt may be decreasing, but the public debt is increasing in a rather unsustainable fashion.
And finally, how much of the decrease in US “private debt” is due to the collapse of commercial real estate markets? Those look to be gone and not coming back any time soon because of the abundance of developed properties available at fire-sale prices. How serious was CRE overexpansion in the UK compared to that in the US? And how much of the loss has actually been acknowledged in either country?
(Typing with a cursor — which I have this time around — is definitely easier than typing without).
VtCodger,
100%, it will take 10 years; 80%, it will take longer. One has to be careful when using these metrics – my measure includes a relation of debt to disposable income. A measure of debt to GDP (which is less telling about housholds) would, of course, be lower.
Yes, total leverage (public plus private) is interesting, too – in the US, it hit 252.5% of GDP in Q2, and is down to 242.2% in Q3.
In terms of commercial real estate, that is not a factor in this metric. Commercial mortgages are quite a small part of the “nonprofit” balance sheet (which is included in the leverage metric).
Any AB readers with insight on the commercial real estate in UK?
Rebecca
One of the big differences between the two countries is residential mortgage lending. The U.K. allows homebuyers–as a rule, not an exception–to borrow 100% of the value of their home, while the U.S. default (i.e., without PMI) is 80%.
So a 30% difference is probably about 30-50% explained by lending practice differences. (If housing prices in both countries fall 20%, the de novo U.S. buyer is now 100% leveraged [80/80], while the de novo U.K. buyer is 125% leveraged. [100/80].)
Which just means the same price drop is magnified due to the higher start in the UK. And if the bulk of that peaking is a decline in asset values (read: homes), the initial assumption that the UK should be recovering more quickly may need to be re-evaluated.