IMF: High household debt triggers crisis

Via the IMF:

Debt greases the wheels of the economy. It allows individuals to make big investments today–like buying a house or going to college – by pledging some of their future earnings.

That’s all fine in theory. But as the global financial crisis showed, rapid growth in household debt – especially mortgages – can be dangerous.

A new IMF study takes a close look at the likely consequences of growth in household debt for different types of economies, as well as steps that policy makers can take to mitigate these consequences and to keep debt within reasonable limits. The overall message: there is a tradeoff between the short-term benefits and the medium-term costs of rising debt, but there is plenty that policymakers can do to ease this tradeoff, according to Chapter Two of the IMF’s October 2017 Global Financial Stability Report.

Given the widespread misery the crisis caused, you might think people have become skittish about borrowing more. Surprisingly, that’s not the case. Since 2008, household debt as a proportion of gross domestic product has grown significantly in a sample of 80 countries. Among advanced economies, the median debt ratio rose to 63 percent last year from 52 percent in 2008. Among emerging economies, it increased to 21 percent from 15 percent.

Reversal of fortune

In the short term, an increase in the ratio of household debt is likely to boost economic growth and employment, our study finds. But in three to five years, those effects are reversed; growth is slower than it would have been otherwise, and the odds of a financial crisis increase. These effects are stronger at the higher levels of debt typical of advanced economies, and weaker at lower levels prevailing in emerging markets.

What’s the reason for the tradeoff? At first, households take on more debt to buy things like new homes and cars. That gives the economy a short-term boost as automakers and home builders hire more workers. But later, highly indebted households may need to cut back on spending to repay their loans. That’s a drag on growth. And as the 2008 crisis demonstrated, a sudden economic shock – such as a decline in home prices–can trigger a spiral of credit defaults that shakes the foundations of the financial system.

More specifically, our study found that a 5 percentage-point increase in the ratio of household debt to GDP over a three-year period forecasts a 1.25 percentage-point decline in inflation-adjusted growth three years in the future. Higher debt is associated with significantly higher unemployment up to four years ahead. And a 1 percentage point increase in debt raises the odds of a future banking crisis by about 1 percentage point. That’s a significant increase, when you consider that the probability of a crisis is 3.5 percent, even without any increase in debt.

The good news is that policy makers have ways to reduce risks. Countries with less external debt and floating exchange rates, and which are financially more developed, are better placed to weather the consequences.

Mitigating risks

Better financial-sector regulations and lower income inequality also help. But this is not the end of the story. Countries can also mitigate the risks by taking measures that moderate the growth of household debt, such as modifying the down payment required to purchase a house or the fraction of a household income that can be devoted to debt repayments. So, good policies, institutions, and regulations make a difference – even in countries with high ratios of household debt to GDP. And countries with poor policies are more vulnerable – even if their initial levels of household debt are low.

Meh. Everything is awesome!

Houses and Holes
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  1. reusachtigeMEMBER

    LOLOLOLOL!!! Been hearing rubbish like this for years. No, it creates everlasting booms!

  2. Debt of 200% of households disposable income; does that mean a household could pay off their debt in two years with their disposable income? Doesn’t sound right, I must be looking at it wrong.

    • If one needs to spend no money on anything else, then yes. But we know that is impossible, hence the old-school bankers rule-of-thumb that mortgage debt be no greater than 30% of (gross) income.

      • If you stop eating, then you solve 2 problems: 1). you can pay your debt quicker, 2). you lose weight and are a lot more likely to attract attention to Reusa’s relations parties.


      • Ino, here in Double-U A people live on meth, so just save that along with your deposit and you’re sorted!

    • Not sure if serious? Disposable income is just your take home income after tax. Cost of living means people only ever have a fraction of their income to put aside (at best). So, no, you can’t just pay it off in 2 years.

    • C.M.BurnsMEMBER

      it’s also combined; all household income vs all household debt. There would still be a significant % of all households that have zero debt (including ours, and from memory, many of the younger readers here on MB). So there are some households with an income to debt ratio that would be high-hundreds % compared to their disposable (ie, after tax but BEFORE everything else) income.

      • good point, this paints an particularly ugly picture once you start digging. This is not going to end well, the non-indebted will share the burden too.

      • the non-indebted will share the burden too.

        Not if they’re smart. The non-indebted will liquidate and become repo men.

      • What was it that former broker said on Four Corners the other week? Most brokers will now happily help load people up with loans of 7-8 times income. The pina colada chick and her boyfriend had debts of more than 11 times their combined gross.

  3. More specifically, our study found that a 5 percentage-point increase in the ratio of household debt to GDP over a three-year period forecasts a 1.25 percentage-point decline in inflation-adjusted growth three years in the future.

    So Australian’s have maxed out the credit cards and household debt, no wonder inflation is low, there is no money for spending on anything else!

    • >(…)Debt greases the wheels of the economy. It allows individuals to make big investments today–like buying a house or going to college – by pledging some of their future earnings.

      Where “some” takes values approaching “all”

      There’s no F in Maths 😀

    • C.M.BurnsMEMBER

      partial contributor (to low inflation) Gavin. As someone said above, CBs all collectively stopped counting those assets that they are deliberately inflating in the numbers.

      So the cost of servicing the mega debt effects inflation on the downside (less spending), but the over-priced asset that caused the debt doesnt make it into the official figures.

      • Yeah agree, it’s nuts that the single-step biggest purchase of someone’s life that is an essential is not counted.

      • C.M.BurnsMEMBER

        Nuts ? Or just Corrupt ? … tomato, tomato

        PS: that phrase really doesn’t translate well to written text 😉

      • Agreed – it is crazy that they stop counting assets for inflation measures.

        Perhaps they are not crazy, though. Perhaps they want the prices of homes to escalate, given that most on the RBA board are property speculators. It is time for them to register their assets, just like MPs.

      • C.M.BurnsMEMBER

        perpetual housing-as-an-asset inflation is essential for the current, broken, model of money creation.

        And now for a more full explanation of this, we now cross to our resident expert, pfh007 (swivels in seat to face camera 3)

        Que Pfh007 in 3, 2, 1…

      • It’s usually spelled “tom-ey-to” “tom-ah-to” – but that’s just nit-picking on my side. 😀


    … Bye bye housing bubble … the former National – led Governments Poverty Creation Programme …

    September’s sales at Barfoot & Thompson were at their lowest level in nine years, with the bottom end of the market the most badly affected |

    As the rate of mortgage borrowing growth continues to slow sharply, David Hargreaves ponders on what level of growth the RBNZ would be content with |

    QV’s latest figures show housing values in Auckland are almost back to where they were a year ago |

  5. Record low interest rates => Record high mortgage debt => Record high house prices = MB’s massive blind spot

    • Edit ( I know it makes it more complicated and therefore takes away from your very valid point that NOBODY on MB will EVER address!!!))
      Record low interest rates => Record high mortgage debt => Record high house prices = Record over-consumption= massive CAD’s = Massive foreign debt = Sell everythig to foreigners to keep up the funding = Record low interest rates – MB’s, RBA’s ,Treasury’s, every Nutty Economics Professor’s massive blind spot

      • An additional blind spot, but on your part, is the assumption that foreigners will buy everything. They have cash but they are not stupid. Like in any flea market, the good stuff is gone early. What is left now is self-igniting pigeon-holes, million dollar fibro shacks and pretty poor agricultural land (the good stuff will soon be fracked).

      • JasonNMan
        Nah! I agree with you. As Herb Stein said – If something cannot go on forever it will stop. The question is when. You might be right about the vertical fibro shacks. Even I was surprised by the numbers from the Lowy institute of the foreign ownership of Rio BHP and a couple of other majors. Aus now owns stuff all of them. This is the RBA from 2011 “The RBA said most estimates suggested four fifths of Australian mining operations were effectively owned by foreign interests.” 2011??? What the hell is it now. I’d seen 86% but if that 2011 number is right and it equates with my own old model which came up with 78% some years before,, then what level is foreign ownership now?

        My point, that I think you are addressing, is in regard to funds available for us to borrow. As long as the Fed and ECB keep printing $2T per year there will be funds headed this way. (I made a mistake not grasping this essential fact at the time of the GFC I suppose I didn’t think they could possibly be as stupid as to do what they have done)They will try to stop but that will cause a catastrophe so they will print again in numbers we cannot now conceive of (same as last time). There’s a ka stage before the next poom (ka-poom theory) Going to be interesting to see how deep that ka gets.

    • Its everyone’s massive blind spot. People are now saying that the RBA can’t raise rates because debt is too high. Problem is if they don’t, its only going to get higher. If house prices stay elevated there’s no way out, every property transaction at these levels raises the stakes.

  6. I just saw a comment on LinkedIn proposing the idea of FIFO in Sydney as a means of working around the ‘housing affordability problem’, with people flying to Sydney from regional areas with cheaper housing. The post had the hashtag #FIFOSydney. I kid you not. We’ve gone full retard. Although the poster was a “wealth coach” / mortgage broker.

  7. @zara
    Hilarious. What people save in rent /mort they’ll pay through the nose in airport commute whether Uber, train or taxi. No doubt silver donut will bump up airport costs with associated growth in crowd – airport congestion tax. Please sir I want some moooore.