The cause of leveraged household balance sheets

While providing her outlook on the US economy and its monetary policy for 2015, President and CEO of the Fourth District Federal Reserve Bank of Cleveland Loretta Mester counted “leveraged household balance sheets” as one of the primary headwinds that have curtailed growth in the US.

The financial crisis indeed left household balance sheets in a highly leveraged state. Inflation was close to 6% and the 30-year fixed mortgage rate averaged around 6.6% in July 2008. Buying a house, or food, or any other necessity became very costly. This caused massive leveraging of the average US consumer’s balance sheet.

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The financial crisis affected all of the sectors in the US economy. Broad-market ETFs, including the SPDR S&P 500 ETF (SPY) and the iShares Core S&P 500 ETF (IVV), sank to record lows. The iShares U.S. Real Estate ETF (IYR) and bank stocks such as JP Morgan (JPM), Citigroup (C), and Bank of America (BAC) also reached record lows.

Deleveraging the US household balance sheet

In an attempt to revive growth in the economy and to help consumers deleverage their balance sheets, the Federal Reserve took to quantitative easing, or QE, in September 2012. The Federal Reserve’s QE program pumped money into the economy. The result has been lower interest rates, tamed inflation, and increased availability of more and cheaper credit directed toward business investment.

In sum, all of this benefited US consumers significantly. Low interest rates mean that households are spending less to service their debts. The US inflation rate is now down to 0.8%, and the mortgage rate has receded to about 3.6%. The concern for the Fed is that the inflation rate may in fact be too low.

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