More Evidence Supporting the House of Debt

August 8, 2014

Economists of all stripes are baffled by continued economic weakness in the United States. The easiest way to see the weakness is to compare where we are in terms of GDP today relative to historical trend growth, something we did in a previous post. It is clear that one of the main drivers of this weakness is the tepid recovery in consumer spending since the Great Recession. We made note of this fact in another previous post, but we are certainly not alone in noticing this fact.

Our book, House of Debt, makes an evidence-based case for what caused the severe Great Recession and what explains the continued economic weakness. The debt-fueled housing boom artificially boosted household spending from 2000 to 2006, and then the collapse in house prices forced a sharp pull-back because indebted households bore the brunt of the shock. The lack of policies targeting this problem exacerbated the effects of the housing crash on consumer spending.

The BEA released state-level personal consumption expenditure data today, and it strongly supports our view. In the charts below, we take the 20% U.S. states that had the largest decline in housing net worth from 2006 to 2009, and we compare them to the 20% states U.S. states that had the smallest decline over the same time period. The states with the largest decline are: Arizona, California, Florida, Michigan, and Nevada. The states with the smallest decline are: Arkansas, Iowa, Kentucky, Louisiana, Nebraska, North Carolina, North Dakota, Oklahoma, Pennsylvania, South Dakota, and Wyoming. We make sure each group contains 20% of the population,  which is why there are more states in the smallest decline category.

Here is total consumption, indexed to 2006, for the biggest decline and smallest decline states:


The pattern is striking. The collapse in total consumption was much larger in states that were hit hardest by the decline in house prices, something we show in our book. It wasn’t just the fact that house prices collapsed. It was also because these states had the highest debt levels when house prices crashed. It was the combination of the two that decimated household spending in these states. Even in 2012, there continues to be a very large difference in the level of consumption. The very large gap between the blue and red lines shows how long-lasting the effects of the housing crash have been.

Total consumption can be broken down into three categories: durable consumption, non-durable consumption, and services. Here are the graphs of all three:




Across all three categories of consumption, there is a large gap between hard hit states and states that largely avoided the housing collapse. And that gap has persisted all the way through 2012. The gap is smallest for non-durable goods like groceries and clothing. This makes sense because these are necessities–even people who have seen their wealth decimated need to eat. The gap is largest for durable goods, which also makes sense given that the housing market directly fuels purchases of durable goods such as furniture, electronics, and home appliances. The services gap is quite large as well, which is a bit surprising to us. Further, the gap between consumption of services appears to be getting larger even through 2012.

Many have argued that we overstate the importance of housing and household debt in explaining the Great Recession and weak recovery. They point to the banking crisis, policy uncertainty, or excessive regulation as equally or even more important. The data released today by the BEA show pretty clearly that the arguments we make in House of Debt remain relevant for thinking about economic weakness today. In our view, the explanation we provide is the most consistent with the striking difference in consumption across states.

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9 Responses to More Evidence Supporting the House of Debt

  1. Logan Mohtashami on August 8, 2014 at 3:07 pmi

    DTI Debt to Income
    LTI Liability to Income

    Without real median income rising you can’t grow in an economy based on debt expansion

  2. JM on August 8, 2014 at 8:51 pmi

    Normalization point is important for understanding the levels, espcially since growth rates seem to be equal after the recession.

    Would like to see these normalized to pre-boom levels (e.g. 2000).

  3. Bud Meyers on August 9, 2014 at 11:59 ami

    That makes because many people borrowed on their home equity (to make home improvements, big purchases, or invest in another property) when the housing market was doing well, and then they got stuck holding the bag when housing prices fell.

    Those that didn’t borrow against their homes, and who had planned to stay living in them anyway, didn’t suffer so much — and many had just refinanced at a lower interest rate right before the housing crash.

    Those who lost their jobs, or whose jobs required them to move, did the worse. They were forced to sell at a lower price or were foreclosed on.

  4. Up the down escalator on August 9, 2014 at 12:58 pmi

    Nice plots. Your analysis is solid. You should follow up with a more important question – why was so much debt taken on? The answer is simple – wages stagnated and people were forced to take on debt to pay for necessities. I include in this student loans.

    Why has the recovery been so slow? The answer is the same, wages fell and costs continued to increase. The younger folks, who often spend more (who are non-pharmacy adds targeted at?), now have loan payments eating up any discretionary spending. And it is the college educated people who used to have the incomes that enabled discretionary spending to drive the economy decades ago.

    The only solution i see is a new federal jobs program with a living wage, that then forces the private sector to compete for skilled labor. The private sector will never raise salaries on their own, the natural state of unregulated capitalism is negotiated monopolies with massive serf labor pools and a small minority of owner-lords.

  5. Jay on August 9, 2014 at 2:01 pmi

    Relabel the lines in these charts as ‘states with robust population growth’ and ‘states with less than robust population growth’. No surprise that consumption would outperform in one of these two groups.

    Variable omission bias from the biased authors.

  6. Jose Romeu Robazzi on August 10, 2014 at 7:25 ami

    I have not read your book, but I think your argument is very compelling. I have worked in many positions in financial markets, inside and outside banks, i have worked in capital markets, credit, and portfolio management. To me, having participated in numerous credit comnitees, it is very clear that entrepreneus don’t stop investing because they became more risk averse. They stop or reduce investment because their capital stock for the equity of new projects is reduced. The idea that credit and only credit allows new investments is laughable, to say the least. It looks incredible to me that macro economic analysts are still thinking in terms of aggregate flow variables, and still haven’t done the micro connection that matters: find a link between aggregate supply and/or aggregate demand to wealth stock of society´s various segments. Maybe I am only ignorant of recent developments, but all this new-keynesian / traditional keynesian discussion seems, at least to me, so off the mark that we should not even look at it. Financial crisis lead to wealth destruction (in most or some society segments), which leads to slow consumption/investment in the following periods. Trying to “restore” household balance sheets by adopting policies that try to reinflate house prices in the hope that people ‘feel rich’ again is not only wishful thinking, it is making housing more expensive for those that are indeed looking to purchase a new house now! We should have policies that try to prevent financial crisis, not stimulate consumption through monetary stimuli.

  7. David on August 12, 2014 at 9:55 pmi

    Dean Baker argues that consumption is not causing the doldrums. Here is a post on his Beat The Press blog from July 24th.

    There is a 1939 paper by Nicholas Kaldor (The Review of Economic Studies, Vol. 7, No. 1 (Oct., 1939), pp. 1-27) in which he states “Mr. Hawtrey is well aware of this constitutional weakness of the bank rate mechanism; and he calls the state of affairs where the mechanism is put out of action through the bank rate having reached its minimum level, a “credit deadlock.” But he is too much inclined, I think, to attribute the emergenceof a “credit deadlock” to past mistakes in banking policy-to the Central Bank not having lowered the rate sufficiently soon, or sufficiently suddenly-rather than to the inherent causes connected with the long-term rate.’ If Professor Hicks’ calculations are right, and 2 percent is now to be regarded as the necessary marginal risk premium by which the current long- term rate exceeds the average savings deposit rate, then a 3 per cent rate on Consols presupposes a 1 per cent average on deposits; and a 1 per cent rate on deposits is perilously near its absolute minimum level. If “full employment” requires a long-term rate which is below 3 per cent, and this is what the monetary authorities aim at, the “credit deadlock” becomes a more or less permanent state of affairs.”

    Unfortunately, Kaldor’s argument is not clearly made, but it seems likely he has explained a root cause of the malaise.

  8. David on August 12, 2014 at 10:00 pmi
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