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on jeremiah and the bear [Nov. 27th, 2007|08:44 am]

In retrospect, it seems self evident: people have too much debt. Chart 1 shows it: from 1985 to today, household debt has risen from 70% of disposable income to 130% of disposable income.

The thing that bothers me, is that I don't really understand exactly what that's saying.

Median income in the US is roughly $50k. Assume that your mortgage payment doesn't exceed 25% of that- a guideline for getting a good rate on a mortgage. This leaves you with about $1k a month for your mortgage payment. At 30 years fixed at 7% interest, $1k a month translates to $150k in mortgage. 20% down means a median house price, to be affordable, is ~$190k. Median house price in 2004 was ~$220k, which means median prices were 15% too expensive that year. OK: but also, assume that housing is 25%, taxes and insurance is 25%, other living expenses 25%, and "disposable income" is 25%. Your total debt is $150k, and your disposable income is $12k, which means household debt for the new purchaser, assuming they behave within reasonable guidelines and have no other debts (ha!) means the ratio is 1200%. Even if housing were your only expense, and the other 75% was "disposable", that ratio would still be 400%.

So, what does it mean when the average household debt has risen from 70% to 130%? It can mean people have been spending beyond their means, or it can mean that there are a greater number of first-time buyers. If the trend is toward a larger percentage of owners, as has been true in recent years, then a larger percentage of people are early on in the cycle. The rising trend could be a scion of excess, or it could be of opportunity. It's likely both: but what do we need to do as a society to favor the latter?

I think the problem is of supply, not demand (I've said this before); and not enough effort is made to supply right-sized, affordable, quality housing.

[User Picture]From: twoeleven
2007-11-27 06:40 pm (UTC)
but your householder is paying that $150k down over 30 yrs. so,

debt/income = $150k / ($12k/yr * 30yr) = 0.41666...

fwiw, here's the fed's official definition of the ratio, which found w/ google(debt to disposable income ratio definition).
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[User Picture]From: hbergeronx
2007-11-27 07:08 pm (UTC)
I saw that link. That link is for the debt service ratio, which is obviously a different number: compare http://federalreserve.gov/Releases/housedebt/default.htm which is the numbers from that calulation, to graph 1 in the economist link. Are you sure that calculation you gave me is how graph 1 is being computed?
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[User Picture]From: twoeleven
2007-11-27 08:38 pm (UTC)
whoops! my mistake w/ the link.

i'm pretty sure that's the right figure: compare this , which is discussing the ratio of debt to total income. it says that the 28% ratio is standard, which is a bit bigger than your 25% reasonable figure. afaik, you have the right definition of disposable income... so, it's the same ratio, but i calcluated it by year rather than month.

despite much more poking around online i can't find a specific definition of the ratio. if it's not done by current account (ie monthly payments / monthly disposable income) i haven't any idea what it could mean.
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[User Picture]From: hbergeronx
2007-11-27 10:10 pm (UTC)
There's about $6.8t in mortgage debt, and about 74m owned households, so the average owned household holds $91k in mortgage debt. Fifteen years at 8% and the average person should be paid off, be debt free, with less than 25% of median household income spent on it. The average household has another $8k of credit card debt, which at a usurious 24% over 15 years is less than $200 a month, still under the 25%. Throw in a brand new car for every household and you maybe hit 36-38%.

This is not a problem of debt load but of liquidity and supply, irrespective of tall tales of the wild spending ways of the average joe.
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[User Picture]From: twoeleven
2007-11-27 10:16 pm (UTC)
right, that's 36-38% debt/total income. maybe i'm confused here, but i thought you were first talking about debt/disposable income.
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[User Picture]From: hbergeronx
2007-11-27 10:29 pm (UTC)
I understand that. The economist example is talking about that, but I don't know what that number is supposed to be or mean or how it's calculated or what the underlying drivers for that number have been. Even at interest rates in excess of current market, the whole nation "could" be debt free in 15 years, is the point of my last comment. If there's a debt crisis, talking about what the burden of debt is seems to me to be a red herring for the actual problem.
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[User Picture]From: twoeleven
2007-11-27 11:05 pm (UTC)
ok. i was just making sure i understand what you're talking about.

i'm not entirely sure what the figure means either. when i was looking for the definition, i found two sets of opinions.

one is that it's a measure of people's financial instability. as the numbers get higher, they have less ability to survive increases in spending (suddenly needing to replace a dead car) or decreases in income (loss of job or investment income).

the other is that it's a measure of people's inability to repay their existing debts (the definition i sent you actually more directly addresses that),ie whether people "could" pay off their debts.

as to wild spending ways, my understanding is that debt load is only half of the data. the other half is savings rate, which istr is negative (or very slightly positive), but in either case, at or near historical lows.
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[User Picture]From: hbergeronx
2007-11-27 11:41 pm (UTC)
so what if the savings rate is negative?

People have "realized" that money market funds/ passbook savings are a terrible way to invest long term, and are drawing that down to put it in equity. That's why, afaik, the savings rate is negative, since stocks, mutual funds, property, and 401k's aren't savings, by official definition.

Problem is, is that those money market funds are pretty much a necessity for writing mortgages.
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