Posted by on December 16, 2016 6:45 am
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Categories: Business Consumer debt Credit Credit card Credit score Credit score in the United States debt Debt consolidation Debt settlement Economy Finance Household debt Lending Club Loan Loans money Personal Consumption Personal finance Personal Income Student Loans TransUnion US Federal Reserve

American consumers love debt, wall street loves securitizing that debt and collecting massive fees for selling it and pension funds, with no viable alternative investments courtesy of accommodative Fed policies, love buying that debt for the extra 25bps of yield it provides.  It’s a “win, win, win”, right?

Well, until it’s not.  While real median incomes in the U.S. have been stagnant for almost a
decade, real household personal consumption has continued its steady
rise as American’s have simply replaced lost income with new debt.  But,
with household leverage near all-time highs and interest rates on the
rise, we suspect this could all end very badly for the U.S. consumer and those pension funds that were forced to “stretch for yield.”

Per a Bloomberg article posted today, the average U.S. household is carrying roughly $133,000 worth of debt, spread between mortgages, credit cards, auto loans, student loans and the newly-popular, crowd-funded, personal loans. 

Debt

To be sure, while staggering, this is nothing new as the growth of U.S. consumer debt has basically gone exponential since the early 90’s.

Consumer Credit

Meanwhile, real median household income has yet to recover to pre-recession 2007 levels.

FRED

That said, up until now, the cost of the staggering increases in notional consumer debt outstanding has been offset by lower interest rates.  As a result, historically low rates have have kept the ratio of household debt service to disposable income levels near multi-decade lows. 

FRED

But rising rates could change all this in the very near future.  As a quick example, lets assume the median household makes $56,000 per year and gets to take home 75% of that, or roughly $42,000.  As we mentioned above, the average household has roughly $133,000 of debt outstanding.  Assuming the average rate on that debt is 5% (which seems generous but stick with us) would imply $6,650 worth of interest payments per year, or roughly 16% of take home pay.

Unfortunately, a significant portion of consumer debt carries floating interest rates.  Therefore, in the most dire scenario, a 1% increase in rates will translate into an extra $1,330 of annual interest payments, $110 per month, and a roughly 3.2% reduction in discretionary personal income. 

So while the fed-induced treasury bubble has been fun for debt-thirsty Americans willing to take on any amount of leverage so long as they can afford the monthly payments, we suspect the unwind is going to be equally painful.

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