Scary Charts

Ezra Klein draws my attention to this chart which Business Week's Michael Mandel calls "the world's scariest chart." It's certainly a bit scary, but I'm not really sure how scared of it we should be.

I imagine, for example, that you could make some kind of chart plotting the ratio of iPod/iPhone expenses to GDP over time. You'd see that after decades of virtuous zero, the ratio has been steadily climbing at a clearly unsustainable rate. You'd see a similar trend in other countries, but with the U.S. far ahead of the pack. Now that's a scary chart. But of course all it would show is that Apple has succeeded in introducing some new products that people like to buy. Likable new products = growing share of GDP going to the products. And that's not scary at all, it's a good thing.

Loans, meanwhile, are, like iPods, a kind of product. And when new debt products are invented, the total amount of debt goes up. But this isn't necessarily a bad thing. The ability to take on debt from time to time is very useful for individuals and institutions alike. And certainly I think most people believe the invention of the 30 year mortgage was a good thing. And while it's of course better not to be carrying massive credit card debts, the whole existence of credit card debt is a consequence of the existence of credit cards and credit cards are, on the whole, useful things to have around. That's why they're so popular, and that's why there's credit card debt.

Which isn't to say that there's nothing to worry about in household debt figures, only that to see what, if anything, we should be worried about we need to know more than the bare fact that debt is on the rise. There are, moreover, some reasons to think that the savings rate in the country is being understated by the fact that things like expenditures on education are counted as consumption when they probably should be looked at as a kind of investment in human capital. After all, a 22 year-old college graduate who paid for school with some loans will be more indebted than a 22 year-old who's been working full-time for the past four years, but the one with the college degree probably has the better financial outlook.

Comments

"Investment in capital" is still "consumption." Yes, the 22-year-old who went to college is probably better off than the one who didn't, but he also has more debt. So if what we're trying to do is measure debt, student loans have to treated as debt. If it's money somebody expects you to pay back, it's debt.

Posted by too many steves | May 9, 2008 2:03 PM

The value of education is not subject to this kind of analysis. If it were, we'd be saying it's great that people are now "investing" $200K in a college education while a generation ago they were only "investing" $20K to get the same education.

Posted by applecor | May 9, 2008 2:05 PM

"The value of education is not subject to this kind of analysis. If it were, we'd be saying it's great that people are now "investing" $200K in a college education while a generation ago they were only "investing" $20K to get the same education."

What matters is the rate of return on your investment, not the amount of the investment. As long as the rate of return is higher than on your next best alternative, go for it.

Posted by Dave | May 9, 2008 2:09 PM

When payoffs (salary) decrease relative to consumption (student loan debt), the chart is pretty scary. They are, and it is.

Posted by alli | May 9, 2008 2:12 PM

a bit off point perhaps, but i'd point out that one of the reasons for increased credit card debt is the fact that the industry moved from simply collecting bills and charging interest to creating all sorts of extra fees. the fees drive much of the profit.

as for the consumer, they've been wracking up increased debt because the cost of stuff [both nessessary and unnessessary] has continued to go up while wages have been stagnent. attending to the morgage payment rather than the credit card bill hasn't helped matters either.

i'm not quite so sanquine about all this increased debt as matt apparently is.

Posted by dj spellchecka | May 9, 2008 2:12 PM

a 22 year-old who's been working full-time for the past four years, but the one with the college degree probably has the better financial outlook.

This is getting less true over time, especially as the cost of college rises. The old standby statistic was that a person with a college degree will make over $1,000,000 more over a lifetime than someone with a high school diploma. I recently read statistics disputing this number (which I can't find now for the life of me) but in 18 years, the projected cost of 4 years of college is over $250,000. This figure doesn't include the enormous amount of interest most people would pay on their loans. Unless something changes, their may come a time when the college degree is actually less valuable than 4 years of work.

Posted by drjimcooper | May 9, 2008 2:13 PM

no, matt. credit cards are "popular" because our corporate culture bullies people into buying stuff they can't afford, and then another wing of that same corporate culture offers those same people money they often can't pay back as a way of addressing that problem. so indeed, as you note, "the whole existence of credit card debt is a consequence of the existence of credit cards" - and that should tell you something about whether credit cards themselves are a good or bad societal phenomenon!

Posted by hmm... | May 9, 2008 2:14 PM

I don't see how a college degree will ever be less valuable than 4 years of work. If you want to make more than 60,000 a year a degree is pretty much a requirement. If you multiply the salary difference times a 40 year career, that number is much, much higher than the 250,000 you spend on college.

Posted by pizzaeagle | May 9, 2008 2:20 PM

I'm going to go with sustained lower prices increasing consumption (meaning the lower interest rates over that period have led to more debt). Whether this is scary or not depends on whether there is some sort of structural break to explain the new trend of lower interest rates and higher debt. And I don't really know the answer to that question.

Posted by DTM | May 9, 2008 2:20 PM

"What matters is the rate of return on your investment, not the amount of the investment. As long as the rate of return is higher than on your next best alternative, go for it."

I was not suggesting that it's a bad investment for an individual (although some other posters above are saying just that, or that it is at least becoming a worse investment than in the past). I'm saying what is also said above, that debt other than "investment debt" reflects a society living beyond its means, and that increasing college debt, EVEN IF you want to call it benign "investment debt" rather than evil "consumer debt", is not a good thing.

Posted by applecor | May 9, 2008 2:21 PM

There is, of course, no evidence that this increase in debt is driven to any significant degree by borrowing for education. Nor, apparently, did Matt look for any.

The idea that education borrowing increased 80% as percentage of GDP since 2000 is just not credible.

Posted by AJ | May 9, 2008 2:22 PM

Credit cards are a problem, in some ways more so are home equity loans. People got mortgages they can barely pay off, then got home equity lines on top of that. Now they can't pay both off, or their home equity line of credit is frozen. They are stuck.

There are reasons to be afraid here. Many Americans, in order to compensate for slowly rising wages, took on more and more debt, as the chart shows. It may be fancy new products, but debt is debt and has to be paid back, or you declare bankruptcy and lose the ability to borrow for some time in the future. And that reduces your options considerably.

Posted by Mimikatz | May 9, 2008 2:28 PM

"What matters is the rate of return on your investment, not the amount of the investment. As long as the rate of return is higher than on your next best alternative, go for it."

Ahh, but what if the expected return is completely wrong? I'd submit to you that for MOST kids going to college today, and paying through the nose/accumulating massive debts, their assumptions of future return are wildly optimistic.

Ditto for the majority of law school grads . . . yes, some will make serious bank, to cover those $40K tuition bills . . . others will find themselves living in serfdom.

I went to public schools (Rutgers College, then Rutgers Law) and graduated when I could fix my loans at under 3%. I'm doing OK. But I know scores of others who are literally suffocating under the weight of student debt.

And then, I have friends who never went to college, work in a trade (electrical, iron working, paving, etc) and are doing much better than the average college grad.

These numbers are seriously troubling. We have created a new class of debt serfs, struggling for years to pay off their gilded entrance pass to the middle class.

Posted by Gary | May 9, 2008 2:29 PM

There seems to be a premise running through your post that if something is popular -- i.e., consumers buy a lot of it -- its consumption can't be, or at least might not be all bad.

That's a faulty premise, unless you're also assuming that consumption in and of itself always inheres some good. In other words, you have to believe that the consumption of a thing that is 100% bad or harmful is not all bad, because the fact of consumption itself inheres some good. (For the economy, presumably....)

I don't buy it. Some loans might be useful, and their consumption -- even increased consumption -- might be a good thing. But some loans are surely bad, and their consumption is likewise bad (all around) -- making increased consumption very bad.

And here it is not the form of the loan (e.g., credit card, home loan) that is at issue in determining goodness or badness, but the "viability" of the loan (to pick a term out of thin air). That is, credit card loans for Person A, under conditions X, might be a good thing, whereas credit card loans for Person B, under conditions Y, might be a bad thing.

The chart above is scary because we all know (as the housing crash demonstrates) that there is a LOT of bad debt out there -- bad loans being consumed. The mere fact of consumption can't redeem the fact of the badness of the loan.

Posted by Jason | May 9, 2008 2:29 PM

I like you a lot Matt but this may be your stupidest analogy of all time.

Posted by Freddie | May 9, 2008 2:31 PM

Actually no hmmm. They are popular because people like the flexibility they offer.

Matt, you are perfectly correct. A better graph would be something along the lines of debt payments as percentage of after tax income for the median household.

Posted by Gabriel | May 9, 2008 2:31 PM

"our corporate culture bullies people into buying stuff they can't afford"

Yes, that's right. Just the other day, I was at Best Buy and the sales guy punched me in the stomach until I bought a plasma-screen tv.

Posted by too many steves | May 9, 2008 2:32 PM

The chart isn't scary. It's asinine. Why should I worry about this debt figure when household net assets are wicked high. You know NET assets, as in assets minus this allegedly scary amount of debt. The net assets of U.S. households are about $57.7 trillion, even after the real estate mess. You can find the Dow Jones link here. That works out to the country having squirreled away 4.2 years worth of GDP, that we own free and clear, after deducting the student loans and Amex bills.

Posted by John Sterling | May 9, 2008 2:35 PM

"Loans, meanwhile, are, like iPods, a kind of product."

This is an absurd analogy. The differences, in terms of economic effect, far outweigh the similarities.

Posted by David in NY | May 9, 2008 2:35 PM

The chart isn't scary. It's asinine. Why should I worry about this debt figure when household net assets are wicked high. You know NET assets, as in assets minus this allegedly scary amount of debt. The net assets of U.S. households are about $57.7 trillion, even after the real estate mess. You can find the Dow Jones link here. That works out to the country having squirreled away 4.2 years worth of GDP, that we own free and clear, after deducting the student loans and Amex bills.

Posted by John Sterling | May 9, 2008 2:37 PM

"I'm doing OK. But I know scores of others who are literally suffocating under the weight of student debt."

I get, figuratively speaking, reams of mail relating to my student loans, but not enough to literally suffocate me.

Posted by Psittakos | May 9, 2008 2:42 PM

The chart isn't scary. It's asinine. Why should I worry about this debt figure when household net assets are wicked high. You know NET assets, as in assets minus this allegedly scary amount of debt. The net assets of U.S. households are about $57.7 trillion, even after the real estate mess. You can find the Dow Jones link here. That works out to the country having squirreled away 4.2 years worth of GDP, that we own free and clear, after deducting the student loans and Amex bills.

Posted by John Sterling | May 9, 2008 2:44 PM

Who is this "we" you speak of John Sterling?

That massive increase in net assets resides in the hands of the very few.

When Stephen Schwartzman makes another billion, "we" are much richer, but my fortunes haven't changed much at all.

Posted by Gary | May 9, 2008 2:45 PM

Matt also misses the real reason the chart is scary. No matter what households were spending that easy credit on, and it almost assuredly was consumption, the trend is unsustainable, as business week guy notes:

So by this calculation, there is $3 trillion of extra debt that are weighing down households. That’s why the financial crisis has prove so hard to solve. The real scope of the problem is not subprime mortgages, but rather this $3 trillion extra debt.

To put it in perspective the recent stimulus bill was $150 billion, 5% of the 'excess' debt.

Posted by AJ | May 9, 2008 2:46 PM

By the way, I agree one problem with higher debt loads is it can make monetary policy less effective (ie, Ben's helicopter money won't do much for consumption if people just use it to pay off some of their debt).

Posted by DTM | May 9, 2008 2:54 PM

I suppose what might be more useful is an examination of household debt rates and ratios (income, overall gdp, etc) and try to see the cause of the recent upward spike. Why did the household debt accelerate around 2001? Did Bush's calls for people go "go out and spend" really make a difference? Is the run up of personal debt related to the run up of federal debt? Is this related to the housing boom?

This certainly is a question that needs a serious examination. Maybe angry bear will have one...

Posted by freddiemac | May 9, 2008 2:59 PM

I don't see how a college degree will ever be less valuable than 4 years of work. If you want to make more than 60,000 a year a degree is pretty much a requirement. If you multiply the salary difference times a 40 year career, that number is much, much higher than the 250,000 you spend on college.

Let's say you go to work in a blue collar trade and you make $40,000 ($20/hr, which I don't think is crazy). Working for 4 years = $160,000. If college is costing $250,000 plus massive interest over time you'd have to make significantly more throughout your career to break even, then pull ahead. As I said before, I recently read that the $1,000,000 more career earnings for college grads may be wrong, and as such, it may NOT make economic sense to invest in a college education.

Posted by drjimcooper | May 9, 2008 2:59 PM

Matt is right that innovation in the financial services industry has made it cheaper/easier to carry debt.

It's also important to remember that countries like China and Japan have been gobbling up treasury securities like mad, which has the effect of keeping long term interest low, further decreasing the cost of debt.

Remember the nasty inflation and exorbitant interest rates of the '70's and '80's? When looking at charts like this, I think it's important to remember that it's just a lot cheaper to borrow money these days than it was even 10 years ago.

Posted by Jeff | May 9, 2008 3:28 PM

Let's say you go to work in a blue collar trade and you make $40,000 ($20/hr, which I don't think is crazy). Working for 4 years = $160,000.

I agree with this generally, but it overlooks some things. Most guys in the trades don't make 40k for a while- it takes a bit of an apprenticeship. Guys right out of high school sure as shit don't make that much. Also, they often don't work year-round like white-collar workers- they're often on unemployment for 3-4 months at 50% or whatever.

As I said before, I recently read that the $1,000,000 more career earnings for college grads may be wrong, and as such, it may NOT make economic sense to invest in a college education

This is becoming more true in my experience. If you get a specific, career-oriented degree(engineering, accounting,nursing,etc), then some student loan debt is a worthwhile investment in yourself. However, most humanites and social science degrees lead to mediocre white/pink-collar cubicle drone work where the average pay is $12-15/hr. For many lower-middle class kids, going into debt to get a history or sociology degree from a 2nd tier public college isn't a great investment. In fact, it's often a shitty investment.

Too many kids attend college because it's an institutional or rite of passage, 'That's what people do after high school'-type of scenario. I'd like to see less people feeling the pressure going to attend college just because they don't know what to do. If a smart working-class kid can go to Amherst or Williams debt-free, go for it. If you have to pay- I don't think the decision is as clear as some people think.

Posted by Waingro | May 9, 2008 3:33 PM

The ability to take on debt from time to time is very useful for individuals and institutions alike.

What has that got to do with your chart? Loans weren't invented in 2000, we're not talking about iPhones here. People actually spent money on houses, cars and gadgets long before Apple came along. 22 year olds still graduated from college. But suddenly, 8 years ago, the debt to GDP ratio began increasing dramatically.

This is a serious problem, if most of that debt was invested in things that have since plummeted in value (say a house that's worth 30% less than what you paid for it).

Posted by Jinchi | May 9, 2008 3:37 PM

mathew: please don't ever post another thing on economics without going back for Econ 101.

Posted by jdevo | May 9, 2008 3:46 PM

"Let's say you go to work in a blue collar trade and you make . . .$20/hr"

That's a little ambitious at 18-22, which is usually more of an apprenticeship period, but the point is still good. Ask any associate at a big law firm to do a similar analysis--the break-even point for law school alone is at least 5 years.

Plus, if you begin retirement savings at 18 (few do), compound interest is a powerful friend on even relatively small amounts.

Posted by zaleriana | May 9, 2008 3:49 PM

Correct me if I'm wrong, but the truly scary thing about the chart is not that debt is rising dramatically, but rather that debt is approaching a 1:1 ratio with GDP.

Posted by My Alter Ego | May 9, 2008 3:50 PM

Question: I am 24-yr-old college grad who works in non-profit and is struggling to pay the bills. Many of my friends who are in similar situations have racked up thousands in credit card debt. One friend already has a bankrupcy on the books. Is there any chance that people are onto something here; namely, that having a huge debt load won't matter in the end because everything's going to collapse anyway? Let's imagine a distopia where everyone goes into huge debt and then all of sudden the rug is pulled out from under everyone. I'm not sure how this would happen but let's just imagine a total market collapse. If this happens, wouldn't have it been smarter in retrospect to just buy $30,000 worth of cool stuff instead of scrimping and saving? I guess what I am asking is, is there any chance at all that by not accuring massive debt, I'm actually sort of screwing myself? Sometimes it just seems like there's no real cost to living far beyond your means.

Posted by Ryan | May 9, 2008 4:01 PM

It isn't a mystery what happened in 2001. At the beginning of 2001, the fed rate was 6.5%. By the end of 2001, it was 1.75%. By the beginning of 2004, it was 1.0%.

And see that leveling off near the end? The Fed began raising rates again in 2004, reaching a local peak of 5.25% by the end of 2006. Of course now it is heading back down again.

So there is your answer: cheap debt equals more consumption of debt. Which is kinda basic.

Posted by DTM | May 9, 2008 4:11 PM

Gary,

I didn't post about the increase in net assets. (Or accidentally triple post if you prefer) I also didn't post about the distribution of wealth. And I didn't post about median versus mean statistics. Who cares about the fat, bank accounts of buyout zillionaires? The point of my last post was that it's ludicrous to kvetch about debt/GDP ratios when US households collectively sit on a mountain of net assets. If you're worried about the equitable distribution of those assets, check the 2002 census data here. 83% of US households had positive net assets (i.e. no net debt). 53% of US households had net assets greater than $50k. 9% had more that $500k. That's more than nine million households. That ain't all Stevie and the buyout kings. The US is not a nation on the verge of penury.

Posted by John Sterling | May 9, 2008 4:33 PM

Look at the chart to see what happened between 2002 and 2007.

I think you've got rose-colored glasses on w/r/t the economy, because what I see is a few people doing spectacularly well and lots of other people drowning in debt.

Posted by Gary | May 9, 2008 5:14 PM

DTM,

Thank you, that was exactly what I was looking for.

Posted by freddiemac | May 9, 2008 6:08 PM

Re: I think you've got rose-colored glasses on w/r/t the economy, because what I see is a few people doing spectacularly well and lots of other people drowning in debt.

Beware of unanalyzed numbers. A small minority of people are indeed drowning in debt, but most people are not. 40% of the population has no credit card debt at all (either they don't have credit cards or they pay them off every month). The median credit card debt load is under $3000, but the avergae is over $9000. That tells us that there are some people with very high debt loads. We should concentrate our concerns with them and ask why. Is it medical debt? Are these people in dying industries? Are there lots of divorcees in the group?

Posted by Jonf | May 9, 2008 6:37 PM

Matt:

you really need to look at the left side of the chart. The "scary" part isn't the fact that debt is increasing, its the fact that debt will soon equal 100% of our GDP. Using you faulty Ipod analogy, if we were spending 60% of our GDP on Ipods, and it increased to 100% of our GDP, we would be in trouble.

Posted by TimB. | May 9, 2008 7:04 PM

The problem with debt is that it's a lien on your future wealth. You trade wealth in the future for wealth now, and you pay more in the future for the convenience of getting it now. For some things this makes sense, houses (how would you ever buy one if you had to save up the whole amount?), education (clearly the increase to your future wealth is worth the lien on that future wealth you've accepted), but there's only so much future wealth someone's going to generate in the future.

So if you compare the amount of wealth we're creating (GDP) with the amount of future wealth we're putting a lien on (debt), what would cause them to diverge from the historic trend line so dramatically recently? Whether the reasons for this divergence are good or bad, more debt ultimately means that more of our future wealth is already spoken for and used, thus we'll have to work just to stay where we already are. The only two things that can get us off that treadmill are increased real GDP growth (i.e. bringing those lines back together) or inflation. I think we all mostly agree on which of those two is more likely in the near term.

Posted by Michael | May 9, 2008 7:19 PM

Has the bottom half of American society, where the marginal homeowners come from, been getting paid more due to stronger unions and less competition from illegal immigrants and foreign trade? Has the bottom half of American society been building more human capital by say, graduating from high school at a higher rate than before? Has the bottom half been developing stronger families so the wife's can back to work if the husband loses his job?

There haven't been any trends in the bottom half of American society to justify the increased percentage of homeowners after 1994. It's all been based on the Bigger Fool theory.

Posted by Steve Sailer | May 9, 2008 7:58 PM

"For many lower-middle class kids, going into debt to get a history or sociology degree from a 2nd tier public college isn't a great investment. In fact, it's often a shitty investment."

Well, then there's Matt's investment in a philosophy degree from a major college.

I'm beginning to think Petey might not be all that wrong in calling Matt a "trust-fund scumbag", given the weight Matt (allegedly) has on foreign policy issues while riding on the back of the philosophy degree - which would be otherwise worthless in the open market.

Posted by Richard Steven Hack | May 9, 2008 8:08 PM