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Markets and Economy

Is Record-High US Debt a Problem?

American institutions, businesses and households have never been more highly leveraged—but that isn’t necessarily a sign of economic trouble brewing.

American institutions, businesses and households have never been more highly leveraged—but that isn’t necessarily a sign of economic trouble brewing.

As the business cycle matures, it’s natural to look for an imbalance building on the horizon. Financial trends have come under particular scrutiny, which isn’t surprising given the market excesses that sparked recent recessions.

While no obvious recessionary trigger is emerging—nothing on par with the run-up in residential real estate prices that preceded the 2008 recession—the amount of leverage in the US economy is growing. American households, businesses and the federal government are carrying a record amount of debt. 

But a closer look at today’s leverage trends reveals little cause for alarm. Debt of all types is growing, but so is the broader economy. Risks appear to be well-balanced, and the nation’s debt burden has actually fallen to historically low levels. There’s nothing unusual about the economy’s financial footprint expanding through the top of the business cycle. Wealth and debt are rising in tandem, and both trends appear sustainable.

Looking Past Absolutes

In absolute terms, the nation’s debts are at an all-time high. The federal government owes $17.9 trillion to the public, and state and local governments carry another $4 trillion in obligations. After a brief decline following the 2008 recession, the debt held by nonfinancial, nonfederal borrowers has grown to a record $33.9 trillion, placing the nation’s total obligations in excess of $50 trillion.

But in the context of broader economic growth, the current level of debt looks benign. As a share of GDP, the nation’s nonfederal, nonfinancial debt is at a 16-year low. And, with interest rates holding at historically low levels, borrowers are having little trouble making their monthly payments. Much of the current debt in the US may also be due to convenience credit, a card balance accrued for rewards purposes but paid off at the end of each month.

The average household’s financial obligations—including payments for car loans, student loans, mortgages and property taxes—consumes 15.25 percent of disposable income, the lowest level since the Federal Reserve began tracking household debt burdens in 1980. Americans may be borrowing more, but most people are still living well within their means.

Putting Trouble in Context

Despite the sustainability of the overall debt picture, the rising delinquency rate for auto loans has been making headlines recently. The portion of borrowers who are behind by at least one payment recently hit a 10-year high.

However, the median credit score of car buyers has also been trending down. In the early years of the recovery, only people on stable financial footing would consider buying a new vehicle. As the labor market improves, people with weaker credit and lower incomes are buying cars. The recession created considerable pent-up demand for vehicles; over the past three years, new car sales have topped 17 million units annually.

A small minority of these buyers are having difficulty staying current on their payments. But this isn’t necessarily a sign of a shaky economy—it may just be the natural consequence of higher-risk borrowers returning to the car lot. 

Foreign Holdings

The volume of US debt held overseas is often cited as a recessionary concern as well—foreign investors now hold $37.8 trillion in dollar-denominated assets, about $10 trillion more than US investors hold abroad. This has led to worries that the US is increasingly reliant on rival powers to underwrite its spending.

In reality, the opposite is true: Asia’s developing nations purchase US debt in order to keep their export-focused manufacturing sectors competitive. The trade imbalances that are driving the accumulation of dollars abroad will eventually fade as living standards in the developing world rise.

Since foreign investors are primarily seeking a place to hold value, their investments are dominated by zero-risk, low-yield assets like Treasurys. American investors, however, tend to seek profits abroad. So while the US is a net debtor nation, American investors actually earn greater returns from their holdings abroad than the US sends to bondholders overseas.   

The Price Is Right

Ultimately, leverage is only an issue when risks are mispriced. In the 2000s, investors failed to appreciate the housing market’s risks. Assuming that real estate would retain its value, mortgage investors provided cheap credit to buyers, allowing an asset bubble to inflate. When home prices fell and homeowners began to walk away from underwater mortgages, investors took crippling losses, sparking the 2008 global financial crisis.

Today, credit is priced far more cautiously. High-yield spreads are holding at 451 points despite low default rates. In past expansions, the high-yield spread has migrated to around 270 basis points when defaults were at current levels. The spread on investment-grade debt is priced at a similarly conservative 150 basis points.

Discipline from the bond market is helping to keep risks balanced. The total volume of debt may be growing, but when credit is priced appropriately, capital will move to productive channels. Contrary to popular belief, leverage isn’t necessarily an Achilles’ heel for the economy—it helps businesses make capital investments in future production and allows households to make the most of their rising incomes. The current trends in leverage are likely the result of a strong economy, not a source of weakness.

View our economic commentary disclaimer.

Jim Glassman, Head Economist, Commercial Banking

Jim Glassman

Jim Glassman, Head Economist, Commercial Banking

Jim Glassman is the Managing Director and Head Economist for Commercial Banking. From regulations and technology to globalization and consumer habits, Jim's insights are used by companies and industries to help them better understand the changing economy and its impact on their businesses.

Jim Glassman

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