Credit-Suisse’s debt strategists go after the Debt-To-GDP chart (right) that we and others have used to conclude that the US economy needs to shed about $25 trillion of debt to get back to sustainable levels. Specifically, they suggest that the chart is “technically wrong and analytically meaningless” (see below).
This is a critical question, and we encourage others to weigh in. If current US debt levels are not, in fact, as stretched as most people think they are, a sustainable recovery could come a lot sooner than most people thingk.
Given the importance of this issue, we’ve taken the liberty of including a long excerpt. We thank Credit Suisse in advance:
Chart I below has been circulating in some form or another for some time. It purports to show how disastrously overleveraged the US private sector has become, and is the most frequently cited piece of information used to justify extremely bearish views about the real economy, banking shares and the equity market itself.
The implicit or explicit argument is that the US private sector debt to GDP ratio must inevitably be cut back to a similar level to the early part of the 20th century, or perhaps even to the levels of the 1950s. This would imply private debt shrinking from 350% of GDP now to between 50 and 150% of GDP, something likely to be associated with a repeat of the 1930s depression or worse.
Unfortunately, this chart is both technically wrong and analytically meaningless in our view. As such it is arguably the most dangerous piece of propaganda to come out of the current crisis.
This is how the (aggregate debt) chart should look… the earlier data was extracted from the Economic Report of the President and adds together household debt and corporate debt, both financial and non-financial. This report was discontinued in the 1970s. The later data comes from the flow of funds accounts and breaks out financial and non-financial debt, starting in the 1950s. The growth in the two measures is very similar for the overlapping periods, but the levels are somewhat different. Chart I splices the two series together, using the higher number as the base.
This does not imply that banks, hedge funds and investment banks did not become dangerously over-leveraged in the last cycle, but it does imply that one could and should look at quite different statistics to measure this. For example, the leverage of hedge funds or investment banks, or the haircuts imposed on different types of collateral in the repo market. These measures of leverage have already plummeted and we see no valid reason to believe that they are still above prudent or sustainable levels. Quite the opposite if anything. “Our third chart looks only at household sector debt to GDP. Here, two points are clear: 1) the household sector was massively underleveraged in the 1950s, and 2) only in the last housing boom did household leverage clearly exceed the levels of the 1920s. If there is a problem with household leverage, then it is a relatively recent one and not necessarily massive in scale.”
Credit Suisse then looks at the level of debt relative to servicing costs, which it concludes are reasonable. Our concern about that conclusion is that interest rates (and, therefore, servicing costs) are unusually low.
…is there any evidence that the burden of servicing the current level of debt is unusually high by historical standards?… This share is currently well below its 10 and 20-year average, though somewhat above its level in the mid-1990s. (chart IV). There is no evidence at all from this ratio that the aggregate household sector has a debt servicing problem.
The real problems lie elsewhere – and in our opinion mostly with the complete failure of market and funding liquidity – and its interaction with securitisation and mark-to-market accounting principles. That problem is quite dangerous enough without having people worshipping false idols such as chart “