Our Debt Problem, Explained

Government debt has remained at a relatively consistent percentage of GDP for the past 50 years, but the debt of companies, consumers, and financial businesses has soared.  The problem now is that the value of the assets that serve as collateral for that debt (houses, stocks, cars, etc.) is plummeting.  Thus, the percentage of debt to equity is increasing, and in many areas, the equity is being wiped out.

This is why economists like Paul Krugman, Joseph Stiglitz, and others think Tim Geithner’s whole view of the crisis is nuts.  We aren’t dealing a “temporary mispricing” of debt.  We’re dealing with the collapse of asset prices that will force the restructuring of trillions of dollars of debt that was loaned against value that no longer exists.

Floyd Norris of the NYT provides a helpful look at the composition of the U.S.’s gigantic debt load.  We’ve blended some of Floyd’s stats with the charts from Ned Davis (below) and the FT (above right).

Floyd’s stats:

Consumer debt has finally begun shrinking as a % of GDP

Financial sector debt hasn’t.

At the end of 2008 total financial sector debt was $17.2 trillion, or 121% of GDP.  At the end of 2007 it was $16 trillion, or only 115% of GDP.

To put this in perspective, in 1958, financial sector debt was $21 billion, only 6% of GDP.

Household debt (consumers) was $13.8 trillion at the end of both 2007 and 2008.  Debt as a % of GDP fell to 97% from 98%.

Debt of nonfinancial businesses rose earlier in this decade and kept growing last year.

In 1958, government debt was 60 per cent of G.D.P. Half a century later, the proportion was just about the same. It has been exploding recently, obviously.

In 1958, 75 per cent of financial sector debt was on the books of traditional financial institutions — banks, savings and loans and finance companies. Now the proportion is 18 per cent.

The rest was securitized.  And the securitization markets have collapsed.  Which is why folks like Bill Gross say that fixing the banks will only fix a small portion of our overall credit system.

And here are the charts.  First, total debt to GDP.  Some complain that this chart double counts whole loans that have then been securitized.  This chart goes through March 31, 2008, and is therefore already a year out of date:

And now non-financial debt to GDP (excludes financial sector):

Note that in the chart above, the 60-year mean is 155% of GDP, and we are now at 225%.  For debt-to-GDP to revert to the mean (on the current GDP), debt would have to fall by about $10 trillion.  If you include financial debt, as in the top chart, debt would have to fall by about $25 trillion.  Those are some serious losses.

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