Americans are cutting their debt faster than other countries and could already be halfway through the deleveraging process, setting the stage for the nation’s economic recovery, says a new report from McKinsey Global Institute.
However, even when U.S. consumers finish deleveraging, they probably won’t be as powerful an engine of global growth as they were before the crisis, warns the report.
According to McKinsey analysts, deleveraging happens in two stages: First, the private sector reduces debt, while economic growth is negative or minimal and government debt rises; then, growth rebounds and supports gradual government deleveraging.
“Somewhat surprisingly, given the amount of concern over the U.S. economy, we find that the United States is furthest along in private-sector debt reduction and closest to beginning the second phase of deleveraging,” says the report.
“The remaining obstacles for its return to growth are its unsettled housing market and its failure to lay out a credible medium-term plan for public debt reduction,” concludes the report.
Since the financial crisis, U.S. household debt has fallen by $584 billion, or 15 percentage points relative to disposable income, which is more than in any other country.
At this pace, Americans could reach sustainable debt levels by the middle of 2013.
The report also found that since the 2008-2009 financial crisis the world’s ten largest developed economies have seen their total debt increase, primarily due to growing government debt.
The U.S., South Korea and Australia are the only countries that have seen a decline in the ratio of total debt to GDP during that time period.
Moreover, the United Kingdom and Spain are deleveraging at a much slower pace, and it could take another decade until their private-sector debt returns to the pre-bubble levels.
In the United States, most of the private-sector deleveraging has happened in the financial sector, where debt relative to GDP had declined to $6.1 trillion from $8 trillion, levels not seen since 2000.
Meanwhile, about two-thirds of household debt reduction comes from defaults on home loans and other consumer debt. And with $254 billion of mortgages in the foreclosure pipeline, more of that is to come, says the report.
McKinsey analysts also warn that because U.S. households will no longer have easy access to the equity in their homes to use for consumption, they are unlikely to return as the driving force of the global growth.
According to the report, between 2003 and 2007 Americans took out $2.2 trillion in home equity loans and cash-out refinancing, and about one-fifth of that went to fund consumption.
“Without the extra purchasing that this home equity extraction enabled, we calculate that consumer spending would have grown about 2 percent annually during the boom, rather than the roughly 3 percent recorded,” says the report.
Consumer finance expert Matt Fellowes says the progress in household deleveraging is not telling of consumer behavior since most of it is the result of tighter loan standards and high loan defaults or write-offs.
“For most consumers, seeing light in the tunnel is only in their dreams at this point,” Fellowes says.
Jefferies chief global equity strategist Sean Darby warns the rate of progress in household deleveraging may diminish because real wages are not growing. He also expects consumption to lag until companies start raising compensation.
But James Paulsen, chief investment strategist at Wells Capital Management, is optimistic: “Consumers are already showing signs of being back, which will become more obvious this year should jobs keep improving.”
“The U.S. quickly forced the banks to write off bad debts to get the overhang off the private sector, forced rates lower to lessen stress, allowed layoffs to quickly readjust company operations, recapitalized banks to reset credit process and allow a quick return to profits,” Paulsen told CNBC.
“This is illustrative of the beauty of capitalism. We go to excess, but also readjust and retrofit equally fast and impressive,” he adds.
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