Next Time Will Be Different
By now, you’ve likely heard discussion of a possible oncoming economic recession. The talk of an inverted yield curve and its predictive ability regarding recessions has been bandied about in the financial as well as the mainstream press.
Is a recession likely? The answer is an unqualified yes. But then again, the answer to that question is always yes. The real question is when it will come. And a related question is how severe it will be.
Let’s review today’s situation. This current expansion began in June 2009 and has now lasted nearly 10.5 years, which makes it the longest expansion in recorded U.S. economic history. The average annual growth rate during this expansion has been approximately 2.2 percent, which is the slowest growth expansion in modern U.S. economic history. Just as a point of reference: The average growth rate of the economy since World War II is 3.2 percent, so this expansion is a full percentage point below average.
Although no one can say with certainty when this expansion will end, we estimate, based on the shape of the yield curve, it will be in late 2020 or early 2021.
As for the severity of the next recession, we tend to look at the recent past to guide us in predicting the future. Doing so this time may cause us to shudder a little because the previous recession (December 2007 to June 2009) was extraordinarily painful – the most severe recession since the great depression of the 1930s. Is the next recession likely to be this painful?
Our belief is that it is not. Four pieces of evidence related to home sales, consumer debt and consumer saving show why we think this is the case.
Volume of Home Sales
Figure 1 shows the recent annual volume of home sales in the United States. The volume of home sales in 2019 is nearly 30 percent lower than it was at the peak in 2005. Although the number of home sales has generally risen since the lowest recent level (2008), home-buying behavior has not come close to matching that in the previous recession.
Figure 1. U.S. Home Sales, 2000–2019
The previous recession was a result, in large part, of excessive activity in home sales, fueled at least in part by exotic mortgages and lending behavior. Clearly, things are very different today, even with aggressive lenders such as Rocket Mortgage.
The Debt Service Ratio
Figure 2 illustrates the debt service ratio, which is the ratio of minimum total loan payments to disposable income. The higher this ratio, the more debt burdened the average consumer is.
Figure 2. U. S. Debt Service Ratio, 1980–2018
The debt service ratio is at its lowest level in four decades and is significantly lower than it was at its peak during the previous recession. There are several reasons for this low level, including that historically low interest rates result in lower loan payments. Massive mortgage refinance in the earlier part of this decade extended debt maturity but also lowered payments, in many cases, significantly.
But the bottom line is that consumers are not burdened by nearly the same level of debt as they were in the last recession. When recession does come, not as many consumers will be on the edge in terms of debt payments, and fewer will be pushed over the precipice into default.
Consumer Debt Levels
Figure 3 illustrates average real (inflation-adjusted) debt per household since 2006.
Figure 3. Real Consumer Debt per U.S. Household by Loan Type, 2006–2018
Note that, for consumer debt other than student loans, the levels are dramatically lower than those during the last recession. Student loans are the wildcard in consumer debt. This data suggests, again, that consumers in general are not overly burdened by debt. However, because millennials carry the majority of student loan debt, when a recession does emerge, they may feel its impact most severely. Most student loans are now issued by the federal government, so those holding student loan debt will not have bankruptcy as an option.
The final piece of evidence that things will be different in the next recession is in the average savings rate, illustrated in Figure 4. The savings rate is the percent of income that consumers save in any type of account – such as deposit, mutual funds, stocks and bonds – and includes 401(k) balances. It is simply the difference between consumer income and consumer spending.
Figure 4. U.S. Personal Savings Rates, 1959–2019
What is abundantly clear is that the average consumer is saving a much higher percentage of income today than before the previous recession. Again, this is good news in that consumers are not nearly as highly leveraged as they were previously.
The Next Recession
Overall, these figures should be heartening. Although we cannot forestall recession, we can expect the next one to be shorter and less severe than the previous one.