Advertisement

Are we heading toward Debt Bubble 2.0?

Are we heading toward Debt Bubble 2.0?
(Alexskopje/Dreamstime.com)

Is another debt bubble about to burst? The Federal Reserve Bank of New York recently reported that total household debt reached $12.73 trillion in the first quarter of 2017, surpassing its $12.68 trillion peak reached in 2008. Before you start panicking, the new record debt level "is neither a reason to celebrate nor a cause for alarm," according to the NY Fed. In fact, "it took an unusually long time from a historical perspective for debt to reach the 2008 level again."

Almost nine years after the last debt bubble exploded, the big change in household debt is its composition. The problem child of the financial crisis of 2008 was debt associated with real estate. But today mortgage loans, which account for just over two-thirds of all household debt, are still below pre-crisis levels.

Advertisement

Part of the reason has to do with the unwillingness of consumers, many of whom struggled to stay afloat amid the worst recession since the Great Depression, to buy anything with borrowed money. Meanwhile, after getting singed in the financial crisis, lenders became far choosier when it came to creditworthiness.

As of the first three months of the year, the median origination score for mortgages was 764 last quarter (FICO scores range from 300 to 850, and anything above 720 is considered to be excellent) and only 3.5 percent of home loans were delinquent, compared to 10 percent a decade ago. In other words, gone are the bad old days when anyone with a heartbeat could snag a housing-backed loan!

But if mortgage debt appears to be in better shape eight years later, the same cannot be said of auto and student loans. Auto loan balances have ballooned to $1.17 trillion, reflecting lenders' willingness to lend to riskier, sub-prime borrowers. Concurrently, as a college education has become an important credential necessary to thrive in the economy, student loan balances have swelled to $1.34 trillion, up from about $500 billion in 2007. Education-related debt has increased every year throughout the 18-year history of the Fed's series on household debt.

When the Federal Reserve report was released, the auto and student loan numbers caused many to wave a flag of caution: Could these two areas sow the seeds of the next financial crisis? After all, until recently, both seemed to be rising at a clip reminiscent of the mortgage run-up in the 2000s, and on top of the sheer scale of the numbers there were warning signs in the form of rising delinquency rates.

Analyst Michael Pearce of the research firm Capital Economics believes that the current situation is not quite as problematic this time around, because although the amount of outstanding debt has risen since the dark days, Americans are doing better. There has "been a significant increase in nominal incomes in the past decade," he says. "Relative to disposable income, household debt is still well below its pre-crisis peak." In 2008, household debt represented nearly 100 percent of household income, compared with 80 percent today. While worrisome, student and auto loan balances combined represent less than 20 percent of household debt.

Still, one big lesson of the financial crisis is that those who ignore warnings may find themselves in peril. Of the two areas of concern, I am keeping a closer eye on student loans, which affect 44 million Americans. As the new administration considers changes to how student loans are serviced, the broader economic impact could be significant.

(Contact Jill Schlesinger, senior business analyst for CBS News, at askjill@JillonMoney.com.)

Advertisement
Advertisement