An involuntary paradox of thrift is coming

By Dave Anderson

EconomPic has a very interesting set of charts on the household debt to asset ratios of the past couple of years. It is not pretty. Basically everyone who had access to the credit market during the Housing and Debt bubble loaded up on debt figuring that it was cheap, and perpetually rising asset prices would bail them out if incomes could not keep up with debt service costs. Whoops!

As a result, the debt to net worth ratio has risen from about 17% in 2006, to 25% by the end of 2008.

But of course, that's not the whole story. Looking at the most recent data (hat tip Zero Hedge) from 2007, we see that the above debt to net worth ratio is significantly higher for the lower and middle class who have saddled themselves with debt in recent years (the lower level for the lower class tends to be smaller as the lowest percentile do not have much / any debt, as they typically do not have access to financing).

That said, the lower and middle class had debt in the range of 30-40% of their net worth in 2007, as compared to the 20% average for all individuals as of that date. The upper 10-percentile had debt at an average of only 10% of their net worth.

We also know that Americans are taking on far less debt. The stock of credit card debt is declining.  Non-revolving debt is also declinning, although at a slower rate.  People are either paying down their debt or at least not taking out new debt.  However disposable personal income is also declining.  Right now debt is shrinking at a slightly faster rate than disposable personal income, so (assuming constant interest rates/fee structures) the proporational debt carrying costs are shrinking for most Americans as the Debt to Income ratio shrinks.

However if disposable personal income continues to shrink, and still assuming constant interest rates, it is possible that the debt burden on American families will be higher even as the debt levels are reduced.  And that assumes constant interest rates, minimal payments and fee structures.  Right now the Federal Reserve is showing that credit card interest rates are either stable or creeping upwards despite the liquidity sloshing around in the system.  We know that credit card minimum payments are increasing if they have not already doubled.  Fees and interest rate spreads are higher now than they were a year ago despite the lack of a financial crisis that could careen into the Great Depression this year.

It is probable that the proportion of family income dedicated to debt service will increase despite the drop in overall lending rates, the massive numbers of implied and explicit guarantees for credit issuers, cheap access to short term funds and the overall drop in net debt levels.  Throw this in with rising health care costs, hard to modify mortgages, sticky assessment values, and the typical American family will see a serious cash flow and �truly disposable� income squeeze in the next year.