Debt Level To Income May Be The Next Great American Tradegy
Written by Kyle Mayers
June 21, 2018 |
Since 1999, the Federal Reserve has tabulated the ratio of debt level to income for American workers.
The Federal Reserve maintains data identifying the ratio of debt to income for all states in the United States. By analyzing and extrapolating this data, it becomes clear that some states are in better shape than others in terms of their debt fitness. Creditors are aware of the risks of too much debt and appear to be putting on the breaks consistently across the nation. But in the end, the level of debt to income in all states appears to be on the rise, and the future looks to be a nation where even larger portions of income are used to pay down debt.
Healthy States, And Those In Trouble
In viewing the debt to income map, it seems like states with an ocean port have worse debt problems than inland states. This trend seems very counter intuitive - port states benefit from industries like fishing and import/export businesses. However, with competition in both fields increasing due to globalization, the costs to enter these fields may exceed the reward.
It is also tempting to assume that ocean facing states are more susceptible to weather events than inland states. Certainly as it relates to weather events that originate with water such as hurricanes and flooding, the impact to these states would be greater. However, inland states also face weather events, such as river flooding and tornadoes. In each case, insurance should cover repairs, however, the disparity between the debt ratio of these two broad categories of states (ocean vs. inland) may indicate that inland residents are better prepared in terms of their insurance coverage than those in ocean facing states. With insufficient insurance coverage, more out of pocket money must be used for repairs. Once that money is depleted, residents may be turning to debt.
Residents in inland states may benefit from more agricultural options than those in ocean facing states. This ability to be more self-sufficient may lead to less dependence on debt in order to survive the daily challenges of life. With the locavore movement (i.e. selecting local food vs. food that is imported) gaining steam among both consumers and restaurants, local farmers may be seeing an uptick in their fortunes.
Among the states with lower debt to income levels there is also a tendency for home prices to be lower. A more expensive home will be accompanied by various percentage based expenses that will compound the difficulties of paying for that home. The interest rate on a mortgage is an obvious example. Less obvious are the charges for insurance or property tax. Owners of more expensive homes are more likely to turn to credit options to finance not only the home, but all of the percentage-based peripheral obligations that come with home ownership.
The Limit of 2
Despite various eras of good or bad economic conditions, debt level per income never seems to tick up much higher than 2, maxing out at 2.13.
Being in debt by an amount that is 2 times your income means getting out of debt will be very challenging. Excluding interest and any cost that draws from your gross pay, it would still take you two years to pay off a debt that large. In reality, you pay taxes, bills and purchase food, and there are few options to avoid spending in that way.
In all likelihood, the limit of 2 has more to do with your credit worthiness once you hit that magical threshold. No lender wants to loan an amount to someone who is certain to be unable to repay it. Once a person's level of debt to income exceeds 2, its pretty obvious that any further debt will be very high risk from a lender's perspective.
The Trend is Up and The Forecast is Down
Despite the limit of 2, the ratio of debt level to income is growing. This reflects lenders willingness to accept more risk, and the general public's willingness to accept a life in which they will always be in debt. The consequences of this type of growth, however, are dire.
Since 1999, annual growth of debt level to income has been small on a percentage basis. Year over year, that growth has averaged 2.66%. Currently, across all states, the average ratio of debt to income is 1.44. By extrapolating that trend into the future, by the year 2044, the average debt level to income will cross over 3.
In order for that to happen, lenders will need to be willing to accept the risk of loaning money to a borrower who is already more than 2 times their income in debt. This relaxation of lending protocol may be one of the few remaining ways to stave off a recession at least on a temporary basis. Thinking back to the recession of 2008, quantitative easing was used to keep more money in supply to help ensure liquidity in capital markets. By allowing more money to flow via relaxed lending standards, banks can kick a major recession down the road. But once that trick has reached its limit, the results will be unsettling. With no more rabbits to pull out of the hat, Americans will eventually be faced with the reality of a recession at some point in the future. Carrying a debt load to income in excess of 2 means that when a recession strikes, the interest payments will feel like anchors dragging American workers under water.
Summary
The state of debt to income is bad today, but the growth of this ratio indicates that the future of workers in America will be one in which more of their income is devoted to paying down debt. Creditors seem to take a ratio of about 2 to be the limit currently, but over time this risk threshold appears to be one creditors are willing to relax. Looking just 16 years down the road, creditors may be willing to tolerate a debt to income ratio of 3. Forces such as globalization and increasing home prices may be to blame for high ratios, particularly in ocean facing states. It will be interesting to monitor this data from the Federal Reserve to see if the trend continues inland, or if American workers can reign in their debt levels.
Have you ever lived in both states with a high debt to income level as well as a state with a low ratio? What differences did you experience? Where do you think debt to income will go in the future? What consequences do you think will be caused by a high debt to income ratio?