Household Debt Poses Few Macro Risks at This Time

Executive Summary

In the second part of our series on debt in the U.S. economy, we focus on the debt of the household sector. Because the financial health of consumers has generally improved meaningfully in recent years, a downturn in the U.S. economy that is caused by financial stress in the household sector does not seem likely, at least not in the foreseeable future. But the rise in auto and student debt could have adverse effects, at least at the margin, on certain individuals and specific areas of consumer spending in coming years.

Household Financial Health Has Generally Improved

In a recently released report, we highlighted the rising amount of debt that the United States has accumulated over the past few decades. Indeed, the combined debt of the American household, business and government sectors is about $15 trillion higher today than it was ten years ago. Yet there are few signs of financial stress in the U.S. economy at present. That is, long-term interest rates are extraordinarily low, the stock market is nearing all-time highs, and credit spreads generally remain tight. But many reasonable observers can rightly wonder if different sectors in the U.S. economy can continue to accumulate debt without eventually suffering adverse consequences. In this second installment in our series on American debt, we focus on the U.S. household sector.

In this report, we draw heavily on analysis we published earlier this year and we refer interested readers to that report for more details. As shown in Figure 1, the amount of household debt outstanding totaled $13.7 trillion in Q1-2019, which represented an all-time high. Mortgage debt accounted for the vast majority (68%) of the total with student loans and auto loans the next largest categories. But it would be mistaken to focus on the absolute amount of consumer debt in isolation.


Rather, one should look at both sides of the household balance sheet. Although household liabilities have risen by $1.6 trillion on balance since 2008, the value of household assets have mushroomed by about $48 trillion over that period (Figure 2). Households have $104 trillion of net worth at present, an increase of roughly 80% relative to 2008.


Not only are consumer balance sheets generally stronger today than they were ten years ago, but the ability of the household sector to service debt is much improved as well. [As shown in Figure 3, the financial obligations ratio, which measures the ability of households to service monthly financial obligations, such as mortgages, auto loans, etc., - fell sharply in the immediate aftermath of the Great Recession as interest rates nosedived]. At only 15.3% of disposable income, the financial obligations ratio currently stands near a 40-year low. Even if the Federal Reserve were to raise interest rates significantly, which does not seem likely anytime soon, the debt profile of the household sector implies that the financial obligation ratio would not shoot higher, at least not for the foreseeable future. As noted previously, mortgages account for two-thirds of overall household debt, and the vast majority of mortgages have fixed-rate structures. Subdued debt growth over the past ten years in conjunction with solid income growth over that period has resulted in a marked decline in the household debt-to-income-ratio, which is measure of household leverage-over that period (Figure 4).


Are Auto and Student Loans a Problem?

In sum, the financial health of the U.S. household sector has improved meaningfully, at least relative to its status ten years ago. That said, there have been some changes in the profile of household debt that could have some financial and economic implications down the line. Although the level of household mortgage debt today is more or less unchanged on balance relative to 2008, the amount of auto loans has risen by nearly $500 billion over that period. Moreover, auto loans to individuals with low credit scores (i.e., FICO scores less than 660) have increased markedly over the past ten years (Figure 5). Origination of auto loans to individuals with FICO scores less than 660 totaled only $84 billion in 2009, but origination ramped up to nearly $200 billion per annum between 2015 and 2018.


But the risk profile of new auto loans has not changed much over the past ten years. Roughly onethird of new auto loans in 2009 were made to individuals with FICO scores less than 660, and that percentage has remained more or less constant subsequently. Furthermore, the amount of outstanding auto loans simply is not in the same ballpark as mortgage loans. There are nearly $1.3 trillion worth of outstanding auto loans today, but the amount of residential mortgages at the height of the housing bubble a decade ago exceeded $9 trillion. A wave of defaults on auto loans, should one occur, would not have the same crippling effect on the economy as mortgage defaults did a decade ago.

The amount of student loans has also increased sharply in recent years. Specifically, there was $600 billion worth of student loans outstanding in 2008, but that amount has mushroomed to $1.5 trillion today. Should we be worried? On the one hand, the threat to the U.S. economy from student loans is, in our view, not as dire as the popular perception seems to be. As in the case of auto loans discussed previously, the amount of student loans today pales in comparison to the outstanding amount of mortgages at the height of the housing bubble. Student loan debt is not likely to bring the U.S. economy suddenly to its knees as mortgage debt did a decade ago.

On the other hand, however, student loan debt could have adverse implications for certain individuals and some segments of the economy. Student loans account for 35% of the total outstanding debt among individuals aged 18 to 29 years old (Figure 6). High debt loads make it more difficult, everything else equal, for those individuals to qualify for mortgages or auto loans, which could exert headwinds on the housing and auto markets. Indeed, researchers at the Federal Reserve Bank of New York (FRBNY) estimate that the increase in student loan debt can explain between 11% and 35% of the 8 percentage point decline in the homeownership rate of individuals in their late 20s.1 In addition, delinquencies could negatively affect individuals' credit scores for a long time, which could also impede their ability to finance other types of spending in the future. In that regard, roughly 9% of student loans are seriously delinquent (i.e., 90 days or more past due), which is significantly higher than comparable rates on other types of household debt such as mortgages, auto loans and credit cards.



The financial health of the household sector has improved markedly over the past ten years. Households have de-levered, net worth has risen significantly and the amount of income that consumers need to service their monthly financial obligations has declined meaningfully. In our view, a downturn in the U.S. economy that is caused by financial stress in the household sector does not seem likely, at least not in the foreseeable future.

There could be adverse consequences for certain individuals and sectors of the economy, at least at the margin. Individuals with excessive auto and/or student loan debt could find qualifying for mortgages or additional auto loans to be more difficult, which could exert some headwinds on the housing and auto markets in the future. But the increase in auto and student loans that has occurred over the past decade probably will not have significantly negative effects on the macro-economy in the near term. We will analyze debt in the non-financial corporate sector in our next report in this series.


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Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.

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