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Samuelson: Will deleveraging unleash economic growth?

Robert Samuelson

WASHINGTON – The deleveraging of America is over, or mostly over – and that's good news and possibly bad. All that "leverage" (loans, debts, mortgages) impeded recovery. Borrowers were overborrowed. Lenders were overlent. Credit standards were too lax. It would take time, we were told, for these excesses to shrink. Borrowers would pay down debts. Lenders would write off bad loans. But now that this ugly process seems mostly done, more money can flow into old-fashioned consumer and business spending. The recovery should strengthen.

That's the good news, and the bad could be: If this improvement doesn't occur, it suggests that the economy suffers from deeper and harder-to-cure ills.

For now, the evidence on deleveraging is overwhelming. All the economy's major sectors, with the conspicuous exception of government, have lightened their financial burdens. This includes households, banks and major corporations. They've reduced their debts or refinanced at lower interest rates so that servicing their loans is less costly.

A new study from economists at Morgan Stanley finds the following, based largely on Federal Reserve data:

• From the last quarter of 2007 to the last quarter of 2013, the debt of U.S. households dropped $638 billion to $13.8 trillion. All the decline occurred in home mortgages (down $1.2 trillion over the same period). Still, credit card debt grew slowly. Moreover, much of the debt – led by mortgages – has been refinanced at low interest rates, says Morgan Stanley. As a result, consumer debt payments as a share of disposable income have dropped to levels not seen since the early 1980s.

• The debt of major nonfinancial corporations (excluding banks, insurance companies and other financial firms) hasn't decreased but has been refinanced at lower rates. Companies are less burdened by debt service. At the depth of the financial crisis in 2009, corporations had about $1.50 of cash flow for every $1 of interest payments they owed. Now the ratio is about $3.50-to-$1. Debt maturities have also lengthened. Stronger cash positions and longer maturities make firms less vulnerable if short-term loans aren't renewed.

• Financial firms have reduced leverage. At the end of 2007, their debts equaled about 110 percent of the economy, or gross domestic product (GDP). At the end of 2013, their debts had fallen to nearly 80 percent of GDP. (Financial firms tend to borrow at one interest rate and hope to earn a slightly higher rate when those funds are lent out or invested.) Banks also have more shareholder capital to absorb losses. In 2008, bank capital equaled about 6 percent of banks' loans, securities and other assets; now, capital is almost 9 percent.

To some extent, deleveraging has liberated the economy from the legacy of the credit bubble. Consumers are in a better position to consume. Businesses are in a better position to invest. Banks are in a better position to lend. There could be a virtuous circle. That's one reason many economists forecast a pickup in economic growth, from slightly more than 2 percent for 2010-2013 to 3 percent for the next three or four years.

It could also be a false dawn. In this economic recovery, forecasts have consistently proved too optimistic. People and firms haven't behaved the way the economic models said they would. The models are based on past behavior. But the financial crisis and recession may have changed how people behave.

A new Federal Reserve study notes that total "labor earnings fell more in the period from 2007 to 2009 than during any other post-war [World War II] recession." Declines occurred at every income level. True, some workers received increases, but their gains were overwhelmed by others' losses. Among the lowest-paid workers, average drops were 20 percent to 25 percent; even among the 90th to 99th percent best-paid workers, the average decline was 9 percent – and, interestingly, the average drop among the top 1 percent was 23 percent. Has this searing experience made consumers so cautious that they might continue deleveraging?

Good question. We'll soon learn whether deleveraging prevented a stronger recovery – or signifies something far more stubborn.

Robert Samuelson’s column is distributed by The Washington Post Writers Group.


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