26/12/2014: Household Leveraging and Deleveraging in the U.S.

Household debt deleveraging is one of the key forces currently still working through the Western economies, suppressing investment and spending, and supporting precautionary savings. The U.S., having entered the Great Recession ahead of many other economies, armed with stronger consumer-centric systems of insolvency and personal bankruptcy, and having exited the Great Recession with more robust rates of economic growth than other advanced economies, presents a good example or a case study for this process.

One recent paper, by Justiniano, Alejandro and Primiceri, Giorgio E. and Tambalotti, Andrea, titled "Household Leveraging and Deleveraging" (see FRB of New York Staff Report No. 602: http://ssrn.com/abstract=2229366) does exactly that.

Per authors, "U.S. households' debt skyrocketed between 2000 and 2007, but has since been falling. This leveraging and deleveraging cycle cannot be accounted for by the liberalization and subsequent tightening of mortgage credit standards that occurred during the period." Quite strikingly, the authors show that financial liberalisation does not fully explain the cycle.

Instead, "…the credit cycle is more likely due to factors that impacted house prices more directly, thus affecting the availability of credit through a collateral channel. In either case, the macroeconomic consequences of leveraging and deleveraging are relatively minor because the responses of borrowers and lenders roughly wash out in the aggregate."

Of course, the only reasons for this conclusion are the factors mentioned above: the U.S. personal insolvency and debt resolution regimes are far more benign, allowing for a more orderly and less disruptive 'washing out' of adverse effects of household debt overhang.