Is a Household Debt Overhang Holding Back Consumption?

Is a Household Debt Overhang Holding Back Consumption?

The recent plunge in U.S. home prices left many households that had borrowed voraciously during the credit boom highly leveraged, with very high levels of debt relative to the value of their assets. Analysts often assert that this “debt overhang” created a need for household deleveraging that, in turn, has been depressing consumer spending and impeding the economic recovery. This paper uses household-level data to examine this hypothesis. I find that highly leveraged homeowners had larger declines in spending between 2007 and 2009 than other homeowners, despite having smaller changes in net worth, suggesting that their leverage weighed on consumption above and beyond what would have been predicted by wealth effects alone. Results from regressions that control for wealth effects and other factors support the view that excessive leverage has contributed to the weakness in consumption. I also show that U.S. households, on the whole, have made limited progress in reducing leverage over the past few years. It may take many years for some households to reduce their leverage to precrisis norms. Thus, the effects of deleveraging may persist for some time to come.

Karen Dynan

Brookings Institution

Spring 2012

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By |2018-01-01T00:00:00-08:00January 1st, 2018|Financial Regulation, Mortgage Finance, Reference|