A couple of years ago, the words “American consumer” cast a shadow over global markets. No wonder. Back in the days of the credit bubble, American consumer borrowing helped to create a crazy debt binge.
And when the financial crisis started in 2007, the ensuing wave of mortgage defaults, particularly in the subprime world, then sparked a panic.
But is it possible that five long years later, those same American consumers might now actually be providing a flash of hope for investors? That is the intriguing idea advanced by a new McKinsey study on the issue of deleveraging, or debt reduction across the western world.
For what McKinsey essentially argues, after analyzing the debt data in numerous countries, is that America has probably done more to deleverage than any other western country. To be sure, that has not affected public sector borrowing; that is still rising, amid policy gridlock, prompting Standard & Poor’s to strip America of its triple A rating last year. Indeed, measured as a whole, the data on total western public and private debt looks predictably dismal, with most countries hovering at combined debt ratios between 200 percent and 500 percent gross domestic product .
Yet, when it comes to those American consumers and financial companies, there has been clear—albeit often unremarked—progress. US financial sector debt has dropped from $8,000 billion to $6,100 billion since the crisis and now stands at 40 percent of GDP, the same as in 2000; US household debt has declined by $584 billion, or a 15 percentage point reduction relative to disposable income. Two thirds of this is due to defaults on home loans and consumer debt. And since there are now $254 billion of mortgages still in the foreclosure process, McKinsey expects that “at this rate [US consumers] could reach sustainable debt levels in two years or more”.
This marks a stark contrast to two other heavily debt-laden nations, namely Spain and the UK: the latter remains burdened by massive financial sector debt and household borrowing, including potentially delinquent mortgages that have not yet been tackled because banks are practicing forbearance; the former is still weighed down by a mountain of corporate debt as well as large volumes of soured property loans.
However, McKinsey does see another geographical parallel: what is happening in the US today potentially echoes the experience of Scandinavia two decades ago. “The deleveraging episodes of Sweden and Finland in the 1990s are particularly relevant today,” it writes. “They show two distinct phases. First, households, corporations and financial institutions reduce debt significantly over several years while economic growth is negative or minimal and government debt rises. In the second phase, growth rebounds and government debt is gradually reduced over many years.”
Is this what investors should now be looking for in the rest of the west today? It would certainly be nice to hope so; indeed, McKinsey argues that “today the United States most closely follows this debt-reduction path”.
But sadly, I fear that some of this optimism about Scandinavian models might be misplaced. For one thing, in the late-1980s and 1990s, Sweden and Finland had the “advantage” of starting their crisis with a relatively low level of pre-existing public debt ; that was not the case in the west in 2007.
Second, both countries were able to grow due to a surge in exports, boosted by a combination of devaluation and strongish demand elsewhere; precisely because their problems were country specific, they were able to ride a bigger wave of global growth.
These days, however, the west is in a very different position; not everybody can try to grow their way out of debt, by exporting at the same time. And then there is a more subtle—but crucial—cultural point. Sweden and Finland were able to take bold decisive measures to implement radical structural reform and stabilize the financial system because they are relatively homogenous countries with functioning political systems. Thus, while there was an initial phase of policy procrastination, once their governments had decided to act, decisions were taken—and, crucially, implemented.
That is not the case in much of the euro zone today; there it is much harder to inspire popular trust in leadership, let alone forge a regional consensus on how to allocate pain. American political institutions are woefully dysfunctional too; just look at the protracted failure to produce any long-term fiscal plan. And even in relation to that mortgage debt, the problems remain challenging. In the coming days, for example, the Obama administration is poised to present new proposals to remove the remaining mortgage rot; these may include ideas such as forbearance for long-term unemployed , or principal reduction.
But these will be highly controversial, particularly in an election year. The grim truth, in other words, is that deleveraging still has a lot further to run in America; let alone the more troubled reaches of the euro zone.