THE DE-LEVERAGING CYCLE HAS ONLY JUST BEGUN

The following is a guest contribution from the analyst team at Annaly Capital Management:

Flow of Funds is one of our favorite collections of data.  It’s big and meaty and has plenty to sink your teeth into, but it’s also only released quarterly and not very timely (12/10/09 release date on 9/30/09 data).  This is clearly not data that will move markets in the short run, so there is no countdown ticker on CNBC for Flow of Funds.  But if you use Ben Graham’s short-run voting machine/long-run weighing machine framework, this is your data series.  Flow of Funds is big picture.  Since nearly every news reporting service around seems to have a piece today about the rise in household net worth, we won’t talk about that.  We also won’t say much about the giant +$2 trillion downward revision to the value of household real estate in the previous quarter, because that’s also been covered elsewhere.  Below are a few of the graphs that we like to update after a new Z.1 comes out.

The first one looks at total credit market debt outstanding, graphed alongside household debt (one of the components).

Total debt outstanding in the economy is still growing, but at the slowest pace on record.  The household has decreased its debt for 4 straight quarters.  You can see just how unique this debt deflation is, given that household debt had previously never fallen year-over-year in the recorded history of this data series.  The household sector isn’t the only one:  the finance and corporate sectors are also putting in their first ever declines in debt during this recession.  We don’t include charts of those sectors because they all look just like the household one above.  In fact, the sum of all non-federal debt is falling.  The process of elimination tells you who is keeping overall debt creation positive:  the US Government, which has grown its debt outstanding by $2.2 trillion since the first quarter of 2008.  This is a big number, when considering that it comes off a base of $5.3 trillion.

It’s tough to say how much debt is too much, so it’s useful to scale the debt outstanding by something.  For the household, we put the debt outstanding in perspective using the income available to service it, creating a debt-to-income (DTI) ratio.

You can see, starting around 2002, the ratio breaks through 100% and slingshots to 130% over the course of only 5 years.  Given how early we appear to be in the deleveraging of this ratio, we could see household debt falling for some time.  If the leveraging that started in the early part of this decade is reversed, and we head back to a ratio of 100%, that would imply a further drop in household debt of around $2.6 trillion, holding incomes constant.  It’s not likely that this deleveraging will walk a straight line, but this should act as a headwind to consumer spending and the economy as a whole.

Source: Annaly