From the NY Times:
A new research paper co-written by the vice chairman of the Federal Reserve says that consumer debt soared over the last six years mainly because of the rapid increase in housing prices.
The research suggests that consumer spending may slow down over the next few years.
The paper will be presented this morning by Donald L. Kohn, the second-highest ranking Fed official after Ben S. Bernanke, during a conference of central bankers in Sydney, Australia. Mr. Kohn wrote the paper with a Fed economist, Karen E. Dynan.
Ms. Dynan and Mr. Kohn say that higher housing prices made many homeowners feel wealthier and more willing to take on debt, which they then used to finance more spending. This spending helped to keep the economy growing at a healthy pace since the last recession ended in 2001.
But the increase in debt “is not likely to be repeated,” according to an advance copy of the paper, unless home prices rise as rapidly as they have in the recent past and mortgages become even easier for borrowers to obtain.
Home prices are already falling in much of the country, and mortgages have become far harder to get in recent months.
Higher home prices also raised debt in recent years by causing families to take out large mortgages in order to afford the houses they wanted.
The Fed’s study, which has been in the works for months, helps highlight some of the difficulties that policy makers are facing.
The authors note that the average household now owes more money than it makes in annual income. In the early 1980s, the debt-to-income ratio was below 60 percent.
The fact that the population is older and richer than it once was explains part of the rise. So do financial innovations that have made it easier to borrow money. But “the increase in house prices — particularly, but not exclusively, over the past half-dozen years — appears to have played the central role,” the authors write.
Among nonhomeowners, the debt-to-income ratio has not risen significantly since the early ’80s, the authors said.
In some cases, the authors said, homeowner families might have taken on more debt than was wise, out of a misplaced belief that the rise in prices would continue for years.
The Fed’s analysis is noteworthy because consumer spending has been arguably the economy’s biggest strength since 2000.
Rising home prices and innovations in the financial sector are the two biggest factors in the spike in U.S. household debt and the related decline in savings, Federal Reserve Vice Chairman Donald Kohn wrote in a research paper presented Sunday.
In a paper presented to a conference held by the Reserve Bank of Australia, Kohn and a Fed economist wrote that a “wealth effect” caused by rising home prices could boost consumption, leading in turn to an increase in household debt. Expenditures for more expensive homes are another factor behind an increase in debt, wrote Kohn and co-author Karen Dynan, chief of the household and real estate finance section of the Fed’s Division of Research and Statistics.
In their paper, Kohn and Dynan noted that the personal savings rate in the U.S. has fallen from an average of 9.1% in the 1980s to an average of 1.7% so far this decade. In the same period, the ratio of total household debt to aggregate personal income has risen from 0.6 to 1.0.