Cheap Debt

Over the past several decdes, household debts have risen considerably over the past several decades. Even though households carry more debt, they don’t spend considerably more in debt repayments. Debt is cheap.

How cheap is debt? The figure below depicts US lending rates since 1960. Data come from the World Bank.1

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Debt was quite cheap in the early-1960s, with lending rates that stood around 4.5%. Beginning in the late-1960s, the cost of debt started to rise. By the 1970s, lending rates had roughly doubled during a period in which general prices were rising quickly and the financial system had trouble delivering credit to those who wanted it. Borrowing troubles eventually became a point of contention in US politics, which ultimately culminated in major changes to credit markets under the Reagan Administration.  Lending rates peaked at nearly 19% in 1981, a period in which the Federal Reserve’s actions to staunch inflation caused a major tightening in credit markets. Since 1981, lending rates appear to have been in steady decline, before reaching very low rates after the 2009 crisis.

 

  1. World Bank (2015) World Development Indicators Data downloaded June 2015 at http://data.worldbank.org/data-catalog/world-development-indicators

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Rising Life Expectancy

The average American born in 1900 could expect to live less than 50 years. Today’s US life expectancy is roughly thirty years longer, and continues to rise. Why has life expectancy risen so much over time?

The figure below describes changes in US life expectancy over the 20th century for men and women. Data come from Noymer and Garenne.1

US Historical Life Expectancy

 

Life expectancy rose fastest in the early part of the 20th century. This represents a continuation of rising longevity over the late-19th century.2At the outset of the century, diseases like diarrhea, tuberculosis, pneumonia or influenza caused many more premature deaths. Infants and children were far more likely to die, and much of these life expectancy gains were the result of more people making it to adulthood. Adults could expect to die at a younger age as well, but the difference was less stark. Life expectancy rose as the result of several developments, like the development of clean water systems, vaccinations, better housing stocks, antibiotics, better food yields and more stringent food regulation (e.g., making it illegal to sell spoiled food).3

Over time, the pace of life expectancy slowed. Falling infant and child mortality rates helped fuel the more rapid rise in life expectancy in earlier decades. Arguably, this was lower hanging fruit. With the passage of time, longer life spans were a matter of delaying death among the elderly. Presumably, there are natural limits to the amount of time that humans can live, though it is uncertain how close we are to those limits today.


  1. Andrew Noymer and Michel Garenne (2000) “The 1918 Influenza Epidemic’s Effects on Sex Differentials in Mortality in the United States”Population and Development Review, 26(3): 565 – 581. Figures from 1918 show an implausible, one-year drop of over ten years, and are recoded as missing. Data available for download athttp://demog.berkeley.edu/~andrew/1918/figure2.html
  2. J. David Hacker (2010) “Decennial Life Tables for the White Population of the United States, 1790–1900” Historical Methods 43(2): 45-79.
  3. David Cutler and Grant Miller (2005) “The role of public health improvements in health advances: The twentieth-century United States”Demography, 42(1): 1-22; Laura Helmuth (2013) “Why are You Not Dead Yet?” Salon, Septemberhttp://www.slate.com/articles/health_and_science/science_of_longevity/2013/09/life_expectancy_history_public_health_and_medical_advances_that_lead_to.2.html

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Workers Haven’t Received Raises in Decades

The hourly wage rate attempts to measure how much workers earn for each hour of work. It is calculated by estimating the total wage payments, divided by the total number of hours worked, economy-wide. In 2014, the average American worker earned about $20.60 for each hour worked, compared to $2.53 in 1964.1

At first glance, this suggests that Americans are better-paid than they were fifty years ago. However, these are nominal figures, which do not account for changing consumer prices. An hourly wage of $2.53 went much further in 1964, when the median home sold for about $18 thousand2, a one-year, 52-issue subscription to Life magazine cost $5, and a gallon of gas cost 30 cents.3

TO get a sense of how well workers are paid today, we need to adjust wages for inflation, which renders an interesting view of wage growth over the past several decades. The figure below, which reproduces a graph from the Pew Research Center’s Drew Desilver4, shows how both nominal and real wages’ growth since 1964.

real wage growth

Although hourly wages have been rising continuously in nominal terms, they have barely moved in inflation-adjusted terms. Between the 1970s and mid-1990s, hourly wages actually fell. Household incomes were rising during this period, but mainly because people worked more hours. A key element of this trend involved more labor force participation: dual-income households became more common, and homemaking became less common. Since the mid-1990s, hourly wages have risen. However, incomes and wages have generally stagnated. Part of what may be happening is that, while workers were paid more per hour of work, they’ve had fewer work hours.

At the end of the day, a lot of this is splitting hairs. In inflation-adjusted terms, hourly wages have barely moved for 50 years.


  1. Bureau of Labor Statistics (2015) “Employment, Hours, and Earnings from the Current Employment Statistics survey (National)” Series ID: CES0500000008 http://data.bls.gov/
  2. US Census Bureau (n.d.) “Median and Average Sales Prices of New Homes Sold in United States”http://www.census.gov/const/uspricemon.pdf
  3. Mary Braswell (2013) “Looking back at life in 1914, 1939, 1964 and 1989” Albany Herald December 26http://www.albanyherald.com/news/2013/dec/28/looking-back-at-life-in-1914-1939-1964-and-1989/
  4. Drew Desilver (2014) “For most workers, real wages have barely budged for decades” Factank Pew Research Center. October 9http://www.pewresearch.org/fact-tank/2014/10/09/for-most-workers-real-wages-have-barely-budged-for-decades/

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More Debt Does Not Necessarily Mean Bigger Debt Service Obligations

Many analysts voice concern about the weight of indebtedness on household finances. Over the past several decades, household debt has risen considerably. In 1950, household debt stocks were 24% of GDP.1 That means that the estimated value of all of the debt owed by US households was roughly one quarter the estimated value of everything produced in the economy. By 1980, it was 45%. By 2000, it was 65%. By 2014, household debt was 95% of GDP – it quadrupled in proportion to national economic production. In the aggregate, households carry bigger debts than they did sixty years ago.

One might infer that households are under greater financial pressure to service these debts. If people are getting bigger mortgages, carrying more credit card debt, more education debt, and so on, wouldn’t they have bigger principal repayments and bigger interest expenditures? Interest and principal payments are collectively described as debt service payments.

That does not appear to be the case. The figure below depicts two data series. The first is the household Debt Service Ratio (DSR), which is the ratio of required households’ debt service payments to their disposable (post-tax) income. The second is the Financial Obligations Ratio (FOR) is a broader measure of households’ financial obligations, and includes debt service, rent payments, auto lease payments, homewoners insurance, and property taxes.

DSO

Households’ debt service ratio did rise between 1980 and 2007, but the rate of change is very modest. In 1980, the debt service ratio was 10.6%, and it peaked in 12.77% in third quarter of 2008. The overall size of household debt stock nearly doubled, but debt service obligations rise by about 20%. Concretely, this suggests that a fairly typical household – for example, one with a disposable income of $50,000, paid $5,300 in debt service obligations at 1980 rates and $6,385 at peak 2008 rates. This translates into about a $90 difference per month. And much of this increase debt service involves repayment of mortgages, which is partly a form of investment.

Why did the burden of servicing debts seem to rise so much more modestly than household debt? In part, it is a product of cheap debt. Credit is less expensive and more abundant today than in 1980. The market for non-traditional mortgages (for example, low-downpayment or adjustable rate mortgages) has developed considerably, and now lends money to people who might not otherwise be able to buy a home. Credit cards are very easy to acquire. The pay day loan industry has grown considerably.

The figure suggests that, if anything, this rise and debt has had a rather modest effect on households’ day-to-day cash flows. Although households are much more in debt, their debt is cheap and plentiful. Cheap, plentiful debt has also been in abundance during the Great Recession and its aftermath, and households have increasingly sought to pay down their debts. All of this has resulted in household debt falling back to the low range of where it stood in the 1980s. Overall, debt service obligations do not seem to be very volatile.

A similar story could be told with the Financial Obligations Ratio. One can really squint at the above figure to discern some very modest growth in household financial obligations between 1980 and 2007. However, it is a substantively mild rise, and it has fallen with debt service obligations since 2008.

The moral of the story? Although household debt is very high, this book has not dramatically affected households’ cash flows. Household finances are not being choked by debt service obligations. The cost of servicing debt has been reasonably stable within a confined range of about 15% to 18%. This is not an earth shattering growth in financial obligations. If debt has some kind of systematic negative effect on household finances, this effect is not manifesting itself as growing debt repayments, relative to incomes.


  1. Federal Reserve Board (2014) “CMDEBT_GDP” Data series from Federal REserve Economic Data set. Accessed in Spring 2014.http://research.stlouisfed.org/fred2

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