For several years, media headlines have been filled with references to a mythical “deleveraging,” or a reduction in the level of U.S. debt. In reality, U.S. non-financial debt has increased, and this has real long-term consequences for the economy. Russ explains.
Tell a lie often enough and people start to believe it. For several years, media headlines have been filled with references to a “deleveraging,” or a reduction in the level of U.S. debt.
The narrative goes as follows: The U.S. was driven into recession by a housing bubble, fueled by excess debt.
Market Realist – The above graph charts the median new home sales prices from 1993 to 2013. You can clearly see the housing bubble as housing prices started inflating in 2001 and reached their peak in 2007. Once the bubble burst, prices decreased until 2010. Prices have started climbing again since then, leaving many worried about a second U.S. housing bubble.
The sub-prime crisis of 2007–2008 was caused largely by the housing bubble in the U.S. (IVV). When the bubble burst, it plunged not only the U.S. but also most of the developed world (VEA) into recession.
The housing (VNQ) boom led to a huge amount of real estate (IYR) speculation and increased consumer spending. Mortgages were lent to all classes of loan-takers (sub-prime lenders included) and then securitized into AAA securities. The crisis unfolded as mortgage holders defaulted on payments, forcing foreclosures on a wide scale.
When the housing bubble burst, mortgage-backed securities plummeted. Banks went into large losses, causing a crisis of confidence that came to a head with the Lehman Brothers bankruptcy. The ensuing credit freeze caused the entire global financial system to come crashing down.
The S&P 500 (SPY) fell almost 57%, from 1,576 in October 2007 to 676 in March 2009. The option-adjusted spreads on corporate bonds (LQD)(HYG) reached highs unlike any ever seen. This indicated high credit risk.
Read on to the next part of this series to see whether the U.S. economy has managed to de-leverage since the financial crisis of 2008 or whether deleveraging is just a myth.