BLOG

The Tale of the Economy & High Leverage

temp-post-image

Household debt has increased as a result of leveraging, which is cause for concern for the overall U.S. economy.

American consumers are in the borrowing mood again, and leveraging is a cause for concern.

Over-leveraging has historically been linked to all U.S. financial crises, and today's high leverage scenario has economists uneasy about its effect on the future of the economy.

Despite deleveraging practices since the financial crisis of 2008, leveraging has been steadily increasing since. With an increase in loans leading to mounting debt, high leveraged loans are expanding the asset bubble that many believe is close to bursting.

Household Debt Jumps Across the U.S.

Following the aftermath of the Great Recession in 2008, consumers tightened the nooses on their spending and borrowing habits in an effort to rehabilitate their financial situation. Yet over the past decade, Americans have been steadily loosening the grips and becoming more confident in their spending habits. They've also started borrowing more.

Today, household debt in the U.S. has skyrocketed since the aftermath of the financial debacle in 2008. Over the first quarter of 2017, household debt clocked in at a total of $12.73 trillion, surpassing the $12.68 trillion peak during the 2008 recession. That's a $479 billion increase from the same time last year, and up $149 billion from the fourth quarter of 2016. This is following 11 straight quarters of growth since deleveraging started right after the recession.

Mortgage balances - which make up the highest contribution to household debt - hit the $8.63 trillion mark over the first quarter of 2017, an increase of $147 billion from Q4 2016.

However, the more alarming contributions to overall household debt include auto loans and student loans.

Outstanding auto loans have reached $1.07 trillion, with a record 107 million Americans holding some level of auto loan debt. Auto loans have been increasing very quickly over the past five years; just 80 million Americans had auto loans in early 2012. Now, more Americans have auto loans than mortgages.

Financial institutions need to take a closer look at their books to offset risky delinquent loans in favor of those that are more profitable.

temp-post-image

Student loans are even more alarming, with about $1.3 trillion outstanding. Over 44 million Americans hold student debt today, with the average graduate in the Class of 2016 having $37,172 in student loan debt.

Along with an increase in debt comes a higher risk of delinquency. Both 30- and 60-day delinquency rates for auto loans increased over the second quarter of 2017 to 2.3 percent, while 11.2 percent of student loans are 90 days delinquent.

Clearly, over-leveraging has an impact on delinquency rates and the economy as a whole.

High Leverage and Its Historical Impact on the Economy

Leverage has long been a driver of economic crises in the U.S., as well as around the globe. This phenomenon has the power to create economic instability when overly accessed, which has been shown time and time again. More recently, leverage played a key role in contributing to the asset bubble in 2008 that inevitably burst, leading to the Great Recession that plagued the nation.

Consumers and corporations are able to make large purchases that they would not be able to make otherwise thanks to leverage. But over-leveraging can have dire consequences, as we have seen with every financial crisis that hit the nation throughout history. Leverage feeds financial distress as delinquencies increase, which is precisely what happened in the Great Recession of 2008.

This particular economic debacle saw a deadly combination of high leverage and credit risk-taking by lenders, driving the development and subsequent breakdown of the real estate price bubble.

Financial Institutions Need to Take a Closer Look at Their Loan Portfolios

In comparison to 2008, bank balance sheets look much different today, with less residential mortgage-based debt and much more student and auto loans, many of which are delinquent and even in default. Student loans have increased in total household debt since 2008 from 4.8 to 10.6 percent of total debt, while auto loans increased to 9.2 percent from 6.4 percent.

With numbers like these, financial institutions would be well advised to optimize their loan portfolios by selling off riskier, delinquent loans, with shorter-term, adjustable-rate loan assets. The quicker lenders and banks can get delinquent loans off their balance sheets, the more profitable they'll be.