Putting your debt in perspective

Russell Price, Senior Economist, Ameriprise Financial

June 2018

Key Points

  • Few things matter more to the nation's economic prospects than consumers' financial health
  • Despite years of steady economic growth, consumer finances remain in solid shape 
  • Current trends in consumer debt levels fail to raise any red flags for the economy

Consumer spending accounts for approximately 70% of U.S. economic activity, according to the U.S. Department of Commerce. As such, few factors matter more to the economic outlook than the health of consumer finances.

We can all relate to the idea that as our debts rise, we eventually have to pull back our spending to pay down our bills and get our finances back in order. The same idea applies to the broader economy. When consumer finances in aggregate become stretched, people eventually have to cut-back on their spending. This shift can contribute to an economic slowdown or possibly a recession.

The state of the American consumer is strong

Fortunately, despite being deep into the current economic expansion (the current U.S. economic expansion will enter its tenth year in July), consumer finances are in decent shape. Historically, consumer debts steadily rise over the course of an economic expansion. This occurs as people become more confident in economic prospects and their own financial situation and less fearful about any detrimental developments in the economy, such as a recession.

In the current expansion, however, consumers have remained fairly conservative in their financial habits. The lessons of the financial crisis (2007 to 2009) are still fresh in the minds of many. New banking regulations, designed to protect borrowers from becoming overleveraged, have also contained loan growth in some segments.

Despite being deep into the current economic expansion, consumer finances are in decent shape.

Consumer debt remains at manageable levels

Headlines are reporting that the dollar value of debt is hitting new highs, but this information does not tell us much unless compared against income (which is also at an all-time high). One of our favorite measurements of consumer indebtedness is the Federal Reserve’s Financial Obligations Ratio (FOR). This metric measures consumer debt payments against consumer disposable income and is a very logical way to assess the situation.

Financial obligations as a percentage of disposable income have been rising as the economy has continued its recovery. This increase is to be expected as consumer confidence rises with an improving economy. But the current ratio of obligations to income is still well below its 38-year average.  

Another way of evaluating consumer finances is to analyze borrowers’ ability to keep up with payments. This statistic is measured by looking at delinquent loans. Although consumer delinquency rates have been edging up in recent quarters, they are still very close to their historical lows.

As of the fourth quarter of 2017, consumers were delinquent on 2.2% of their outstanding loans, according to Federal Reserve data. This number was up from the all-time low of 1.9% as measured in the first quarter of 2015, but it is still well below the 20-year average of 3.4% prior to the financial crisis of 2008.

Consumers are being smarter about credit card debt

Recent news stories accurately note that consumer revolving credit (primarily credit card debt) is at an all-time high, eclipsing levels seen just before the financial crisis. But, consumer income is also at highs. Overall, consumers are well positioned to keep up with rising credit card bills.

For example, credit card debt as a percentage of consumer income is currently 6.1%, not far removed from the 20-year low of 5.8% recorded in 2016 as reported by the Federal Reserve. Such levels are well below the average 7.6% of income to credit card debt represented from 1995 to 2010, according to the Bureau of Economic Analysis.

Consumer health is a positive sign for the economy

Some wonder if recent market volatility is a sign that the U.S. economy may be on the cusp of its next recession. There’s no doubt that the economy faces near-term challenges, such as rising interest rates, inflation pressures and trade disputes. Nevertheless, fundamentals — including consumer debt levels — remain supportive, and we believe the odds of a recession are low. However, we believe financial market volatility is likely to remain heightened over the near-term as markets react to these economic challenges.

Consumer debt levels, despite the headlines, are quite reasonable given the current state of the economy.

Market fluctuations may remind investors of the importance of managing their finances wisely. Continue to balance debt obligations with spending and saving goals, as well as consider revisiting your overall portfolio risk comfort levels. Your financial advisor can work with you to help ensure you are prepared for market turbulence and your portfolio remains on-track to meet your unique financial goals.