US Sovereign Risk: Growth of Debt in the US

Much of the economic-financial and policy dilemma surrounding the Great Recession has to do with the growth of debt in the US as shown below. The very high debt levels relative to income are a new problem that constrains an economic recovery in the US and much of the developed world. High debt levels relative to the ability to service the debt changes the behavior of all parties including the borrowers, the lenders and similarly the debt constrained government entities that are called upon to backstop the faltering private sector. Hence an overdose of debt relative to income compromises the government’s efforts to promote spending either through monetary or fiscal policy consumers seek to retire debt rather than spend and banks seek to lend to the Treasury rather than businesses in an effort to rebuild their capital ratio with as little risk as possible Furthermore to the extent bank loan extensions occur bank lending rates have leaped so the cost to borrowers from existing debt levels further compromises spending and economic recovery.

US Debt Ratio

As the graph indicates debt to income in the US has been on the rise for the entire post- WWII period. While some of this is a reflection of economic comfort after 25 years of The Great Moderation of steady income growth that would allow one to consumer today and comfortably pay for it in the future. Further incentives to borrow and pay for it later followed from the almost unbroken record of inflation in the Post WW II US economy making it less costly to retire debt as long as prices and wages continuously increase hence reducing the real cost of debt. Additionally, the tax code favors debt in private capital structures as interest payments on debt “shield” income from taxes. Additionally there has been a technological advance in finance making non-institutional debt more easily sold on capital markets. The securitization of almost any kind of debt that can be packaged and converted to rated, market traded, investment grade debt is easily placed with the major institutions not just because of the perceived elevation of asset quality but risk based capital regulation allows institutions to satisfy minimum capital ratios with a more leveraged portfolio

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