New Borrowing minus Payback = Change in Debt

We were looking, a few days back, at cost-of-debt graphs. Geerussell linked to How much income is used for debt payments? A new database for debt service ratios by Mathias Drehmann, Anamaria Illes, Mikael Juselius and Marjorie Santos.

I re-read that article this morning and made sense of it this time. Some things it says should be obvious:

Debt service ratios (DSRs) provide important information about the interactions between debt and the real economy, as they measure the amount of income used for interest payments and amortisations...

These debt-related flows are a direct result of previous borrowing decisions and often move slowly as they depend on the duration and other terms of credit contracts. They have a direct impact on borrowers' budget constraints and thus affect spending.

Since the DSR captures the link between debt-related payments and spending, it is a crucial variable for understanding the interactions between debt and the real economy.

(By "amortisations" they mean repayment of principal. So they are looking at more than just the cost of interest. Interest and principal, both. Debt service.)

Some of what they wrote was plain interesting:

... during financial booms, increases in asset prices boost the value of collateral, making borrowing easier. But more debt means higher debt service ratios, especially if interest rates rise. This constrains spending, which offsets the boost from new lending, and the boom runs out of steam at some point. After a financial bust, it takes time for debt service ratios, and thus spending, to normalise even if interest rates fall, as principal still needs to be paid down.

After a financial bust, it takes time for debt service ratios, and thus spending, to normalise even if interest rates fall, as principal still needs to be paid down.

But Jim has pointed out that "The amount of debt for households hasn't changed much in the last 8 years." He's right:

Graph #1: Household Debt. The circled point on the graph is Third Quarter 2007, eight years back

Principal still needs to be paid down.

The change in household debt was that it stopped going up so fast. That seems to agree with Dr. Econ's graph showing a sudden, screeching halt in Household Net Borrowing:

Graph #2: Household Net Borrowing is "the difference between borrowing and saving during a period"

When new borrowing drops to nothing, debt stops increasing.

But look at Household Debt in comparison to "Debt Service Payments as a Percent of Income":

Graph #3: Household Debt Continued to Grow Faster Than Debt Service Payments

You wouldn't know by Graph #3 that there had ever been a financial crisis. There's barely a wiggle on the graph. And debt continues to increase faster than we can manage to pay it off.

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  •  Debt will always increase unless we pay it off faster than we take it on.
  •  If debt always increases, you must eventually have a crisis.
  •  The longer debt reduction is postponed, the bigger the crisis.