Since 2008, the United States has been stuck in a painful deleveraging cycle; the recession was caused by an overabundance of mortgage debt, and it is perpetuated by the low aggregate demand caused by unemployment and deleveraging, leading to anemic economic growth.

A new report from the McKinsey Quarterly, on the deleveraging process in developed nations, reports that the United States is doing better than Spain and the United Kingdom in paying down what we owe — take that, Europe! Still, there isn’t that much else to celebrate.

Household debt in America declined by $584 billion in the period of time between the end of 2008 until midway through last year. That figure, half a trillion dollars, represents only 4% of all household debt, though.

Furthermore, we didn’t pay down $584 billion in principal, far from it — “defaults account for about 70 and 80 percent of the decrease in mortgage debt and consumer credit, respectively.”

Ouch. This isn’t necessarily a good sign, but it’s a necessary process.

Debt Overwhelms Income

McKinsey claims that as much as 35% of mortgage defaults are strategic  — that is, homeowners walk away from their mortgage on an underwater home and face the consequences instead of disappearing their money into a pit.

It has been argued that more American should be doing this. McKinsey points out that America makes this easier than other nations because “in 11 of the 50 states — including hard-hit Arizona and California — mortgages are nonrecourse loans, so lenders cannot pursue the other assets or income of borrowers who default.”

It’s a painful process, but we may be approximately halfway through it, according to the report. McKinsey created a graph showing the rapid growth of the ratio of household debt to gross disposable income. At the peak of the crisis, this ratio hit nearly 130%, roughly 35% above historical trend. The United States has already lowered this ratio by 11%, bringing it halfway closer to the roughly 100% ratio historical trends would suggest.

But could the United States deal with a 100% debt-to-diposable-income ratio? This, it seems, is the only dangerous assumption inherent to the report: that the only problem with US household debt ratios was it was above historical trend. Many economists have pointed out that part of the reason for the crash was stagnation in real wage growth combined with rising costs over three decades — not just during the housing boom; families were forced to take on more and more debt just to keep up, and the bubble eventually burst.

Their argument seems to suggest that by returning to the 1980-2000 debt ratio trend, our economic woes will be fixed.

Following this logic, we’ll return to unsustainable levels of household debt ratio in two decades. Perhaps sustainable and inclusive growth will require still more deleveraging.

See the report here.

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