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The far-reaching effects of U.S. household debt

It is unlikely that the household debt crisis will be resolved in the foreseeable future.

July 21,2008
Household debt in the United States has surged, nearing the country’s nominal gross domestic product. As of the end of 2007, debt totaled $13.8 trillion (99.9 percent of nominal GDP). In particular, mortgage loans, which have surged since 2000, now account for 76.0 percent of household debt. The soaring default rate of mortgage loans triggered the subprime mortgage debacle, adversely affecting the economy. To make things worse, with global liquidity shifting to commodity markets after the real estate bubble popped, prices of crude oil and grains have surged, further worsening debt servicing capabilities of U.S. households, which could lead to a very serious recession. Therefore, it is necessary to take a closer look at the issue of U.S. household debt ? the key to economic recovery in the United States.

The debt surge was mainly due to excessive consumption and increased housing prices. Excessive spending by U.S. households became conspicuous beginning in 2000. Indeed, private consumption has persistently exceeded its long-term equilibrium level by about two percentage points.

Rising housing prices, which increased precipitously since 2002, burdened home buyers by forcing them to borrow more money to pay for their new houses. In addition, an increase in speculative home buying compounded the nation’s household debt problem.

Complementing the situation were other factors: a low interest rate policy, deregulation and financial innovation. Since the IT bubble subsided, the Federal Reserve kept its target rate at less than two percent for three years, encouraging a spending spree which caused the housing market bubble. The expansion of the mortgage market, driven by deregulation of mortgages and the proliferation of various mortgage-backed securities, was another cause behind surging household debt.

However, as the Fed raised its target rate in response to both higher inflationary pressure (coming from surging commodity prices) and excessive liquidity, the bubble began to deflate. In other words, as borrowers felt a heavier burden to pay off their principal because of increased interest rates, the number of insolvent households surged with skyrocketing delinquencies.

The U.S. housing market is expected to decline until 2009 due to decreasing demand and increasing vacancy rates. Banks will raise the bar on household lending while upward pressure will mount on interest rates. According to Samsung Economic Research Institute’s recent statistical analysis, household debt will go through about a four-year adjustment period with an annual increase rate of less than four percent.

It seems that adjustments of household debt have already begun since the fourth quarter of 2006. The U.S. economy is unlikely to turn around for the next several years due to both the decreasing net assets of households (lower house and stock prices) and subdued consumption caused by an adjustment of household debt.

A highly excessive debt burden amplifies risk in the overall economy. But the U.S. monetary authority failed to heed the growing problem. Now, despite efforts made by authorities that include the Treasury Department, it is unlikely that the household debt crisis will be resolved in the foreseeable future.

The U.S. economic slowdown will also adversely affect the global economy, particularly industrialized nations.

Korea’s response to the current situation should be to strengthen its efforts in risk management in preparation for a protracted slowdown of the global economy and further volatility in global financial markets. The household debt of Korea is also quite high, even though it suffered from its own household debt crisis in 2003 due to a credit-card bubble. To be specific, the level of household debt has rapidly increased, reaching as high as 87.6 percent of GDP as of the end of 2007. Furthermore, Korea’s home equity loans are more vulnerable to changes in the financial environment (such as an increase in interest rates) since most are short-term, adjustable rate loans.

Therefore, financial institutions are recommended to maintain sound assets through efficient risk and asset management and the government should strengthen the prudential supervision of financial institutions along with its efforts to create a soft landing for the household debt problem.

The writer is a research fellow at the Global Studies Department, Samsung Economic Research Institute (www.seriworld.org). Inquiries on this article should be addressed to serihs.park@samsung.com.


By Park Hyun-soo



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