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Is the rise in consumer debt a myth?


This is an interesting post by Carl Smith arguing that consumers aren't that much more indebted than they used to be. What's really going on, he says, is that credit cards and other forms of consumer finance have replaced informal ways of getting money that don't show up on a balance sheet (asking your parents, your friends, your loan shark) with formal loans that do show up in the numbers.

By Ezra Klein  | September 29, 2010; 11:05 AM ET
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"This is an interesting post by Carl Smith arguing that consumers aren't that much more indebted than they used to be."

I think Carl is right given the categories he is looking at, though he's excluding the 800lb Gorilla (mortgage debt). Toss in mortgages, and households are in a lot more debt than they used to be.

There are also some distributional effects which are ignored on the consumer side of things (I doubt anyone graduated from Med/Law school in 1985 with $200,000 worth of student loans but it does happen today).

"However, there is a more fundamental question – can this go on forever? Can we pile more debt on top of more debt. Yep, we sure can. There is no limit.

To prove this I am offering to loan one of my co-bloggers (either can take up the offer) $100 every millisecond on the millisecond. All I ask in return is that they loan me $100 every millisecond on the millisecond."

By the way, the above exchange is silly. In the reality, debt isn't just person A and person B loaning money back and forth. It's not just a series of offsetting transactions.

Person A lends to person B, and if Person B can't make his payments, Person A might not make good on his own loan to Person C, who then doesn't buy stuff from Person D who in turn fires Person E who defaults on what he owes to Person C who is now so blown up he also stops buying things from Person F who fires Person G and H, who in turn default on their own obligations.

Debt isn't all bad (and in reasonable quantitites can be quite useful), and the system can tolerate the occasional screw up. That said, a surge in total debt both increases the risk that a given borrower will default, and that the default will be larger when it comes. As an aside, the surge in debt redirects and focuses economic activity onto certain 'hot' sectors, and when the debt bubble blows up suddenly that sector goes cold for a long time and a whole bunch of people - and those in other sectors who grew along with the 'hot' sector - need to figure out some other way to make a living. As we have seen, this process is painful.

Even pure offsets can be risky. This happened with credit default swaps.

A trading desk would buy protection from one party and sell it to another, and consider the risk offset (if the underlying on the credit default swap defaulted, the desk receives money from whoever sold the desk protection and simply sends it to whoever bought protection from the desk). It was a huge problem when the guy the desk bought protection from (AIG) was at risk of blowing up at the same time as the underlying on the credit default swap.

Posted by: justin84 | September 29, 2010 12:18 PM | Report abuse


The debt level has freaking DOUBLED over the timespan of that graph, and that's insignificant?


Posted by: vorkosigan1 | September 29, 2010 1:34 PM | Report abuse

Actually, the debt level "freaking DOUBLED" in the first 25 years and has fluctuated in a pretty narrow range in the ensuring 35. If the argument is about consistently mounting debt, the graph shows a change more that a generation ago and something close to stability since. Perhaps you can stay for dessert after all.

Posted by: zimbar | September 29, 2010 1:59 PM | Report abuse

Good lord, that looks like Yglesias posted it. One "fluctuated", "ensuring" should be "ensuing" and "that" should be "than."

Posted by: zimbar | September 29, 2010 2:01 PM | Report abuse

My consumer debt has FAR more than doubled in 25 years as I continuously increased my use of credit cards (which I pay off every month) as a substitute for cash/checks. I'm still increasing this form of substitution as I increase use of the internet to buy things and pay bills. Does even Carl Simon (nice work) overestimate the growth of consumer debt in the sense that the metrics are inflated by this substitution effect? I suspect so.

Posted by: pjro | September 29, 2010 2:22 PM | Report abuse

My favorite part is "If you can borrow from VISA at 9% APR then that might be better than borrowing from Mom and Dad and paying the implicit and nearly infinite APR of weekly scoldings and endless guilt." First, if you can borrow from VISA at 9% please tell me how. Second, when you look at his chart of total debt as a fraction of disposable income it appears clear that two distinct trends emerged. Between 1959 and 1992 revolving debt appeared to replace non-revolving debt as Carl suggests. Then, in 1992 both revolving and non-revolving debt increased, resulting in a substantially higher debt to disposable income ratio.

We're now observing the consequences of this binge, especially since the underlying assets that offset many of the liabilities listed in the above graph may be substantially over-valued.

Posted by: besmit02 | September 29, 2010 3:51 PM | Report abuse

One major problem with the graph is that the data is not disaggregated by income levels. The total debt and asset levels may be constant, but if you have an overwhelming majority of the population carrying more debt, while the assets are concentrated in a much smaller segment of the population, it's likely to create an economic imbalance.

Posted by: JPRS | September 29, 2010 10:58 PM | Report abuse

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