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Household leverage in the United States and many industrial countries increased dramatically in the decade prior to 2007. Countries with the largest increases in household leverage tended to experience the fastest rises in house prices over the same period. These same countries tended to experience the biggest declines in household consumption once house prices started falling. “[O]ver-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money.” —Irving Fisher (1933) In the United States and many other industrial countries, the recent financial crisis contributed to the longest and most severe economic contraction since the Great Depression. The rapid expansion in the use of borrowed money, or leverage, by households in recent years, is one factor that may help account for the virulence of the downturn. In the years leading up to the crisis, a combination of factors, including low interest rates, lax lending standards, a proliferation of exotic mortgage products, and the growth of a global market for securitized loans fueled a rapid increase in household borrowing. An influx of new and often speculative homebuyers with access to easy credit helped bid up U.S. house prices to unprecedented levels relative to
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FRBSF ECONOMIC LETTER
2010-01 January 11, 2010
Global Household Leverage, House Prices,
and Consumption
BY REUVEN GLICK AND KEVIN J. LANSING
Household leverage in the United States and many industrial countries increased dramatically in
the decade prior to 2007. Countries with the largest increases in household leverage tended to
experience the fastest rises in house prices over the same period. These same countries tended
to experience the biggest declines in household consumption once house prices started falling.
“[O]ver-investment and over-speculation are often important; but they would
have far less serious results were they not conducted with borrowed money.”
—Irving Fisher (1933)
In the United States and many other industrial countries, the recent financial crisis contributed to the
longest and most severe economic contraction since the Great Depression. The rapid expansion in the
use of borrowed money, or leverage, by households in recent years, is one factor that may help account
for the virulence of the downturn.
In the years leading up to the crisis, a combination of factors, including low interest rates, lax lending
standards, a proliferation of exotic mortgage products, and the growth of a global market for securitized
loans fueled a rapid increase in household borrowing. An influx of new and often speculative
homebuyers with access to easy credit helped bid up U.S. house prices to unprecedented levels relative to
rents or disposable income. U.S. household leverage, as measured by the ratio of debt to personal
disposable income, reached an all-time high, exceeding 130% in 2007 (see Glick and Lansing 2009).
National house prices peaked in 2006 and have since dropped by about 30%. The bursting of the
housing bubble set off a chain of events that pushed the U.S. economy into a severe recession that started
in December 2007.
This Economic Letter shows that the recent U.S. experience is by no means unique. Household leverage
in many industrial countries increased dramatically in the years prior to 2007. Countries with the largest
increases in household leverage tended to experience the fastest rise in house prices over the same
period. Moreover, these same countries tended to experience the most severe declines in consumption
once house prices started falling. The common patterns observed across countries suggest that, as in the
United States, the unwinding of excess household leverage via increased saving or increased default rates
could be a significant drag on consumption and bank lending going forward, possibly muting the vigor of
the economic recovery.
FRBSF Economic Letter 2010-01 January 11, 2010
2
Household leverage and consumption: U.S. county data
The typical residential housing transaction is financed largely with borrowed money. The use of such
leverage to purchase an asset magnifies the risk assumed by the buyer. If the value of the asset
subsequently drops, as in a burst bubble, the debt incurred to buy the asset remains in place and the
buyer must still repay the loan in full. If the debt exceeds the asset’s market value, refinancing options
are limited. If the debt is very large relative to the buyer’s income, repayment can strain the buyer’s
finances, forcing a reduction in other spending. And if the strain becomes too great, the buyer may be
forced to default, shifting some or all of the loss to the lender or the taxpayer if the loan is government-
insured.
Using data on household borrowing for the 450 largest U.S. counties by population, Mian and Sufi
(2009a,b) provide evidence that the rapid rise in household leverage in recent years was a primary driver
of the recession that began in December 2007. Their analysis identifies several important patterns. First,
they find that house prices rose faster in areas where subprime mortgages were more prevalent. This
suggests the existence of a self-reinforcing feedback loop in which new buyers with access to easy
mortgage credit helped fuel the run-up in prices by bidding competitively for houses, which in turn
encouraged lenders to ease credit even further based on the assumption that house prices would
continue to appreciate indefinitely. Second, the authors find that for each incremental dollar of house
price appreciation, the average homeowner extracted about 25 to 30 cents in cash via home equity
borrowing, which was used primarily for consumption or home improvement. This indicates that house
price appreciation fueled by easy mortgage credit was a significant driver of economic growth during the
boom years. Third, they find that counties that experienced the largest increases in leverage tended to
experience the sharpest rise in loan defaults and the most severe recessions, where severity is measured
by the subsequent fall in consumption of durable goods or the subsequent rise in the unemployment
rate. The last point suggests that recession severity in a given area reflects the degree to which prior
growth there was driven by an unsustainable borrowing trend—one which came to an abrupt halt once
house prices stopped rising.
Household leverage and
consumption: International data
As in the United States, household
borrowing in many industrial countries
grew rapidly in the years leading up to
the financial crisis. Figure 1 depicts the
increase in the household leverage
ratio, defined as household debt as a
percent of disposable income including
transfers, in the United States and 15
other industrial countries over a 10-
year period ending in 2007, according
to data from the Organisation for
Economic Co-operation and
Development. Compared to the U.S.
household leverage ratio of around
130% in 2007, leverage ratios were
Figure 1
Household leverage ratios: Debt to disposable income
Note: The following countries use different data years: Japan 1997, 2006;
Spain 2000, 2007; Ireland 2002, 2007.
0
50
100
150
200
250 1997 2007
%
FRBSF Economic Letter 2010-01 January 11, 2010
3
significantly higher in some countries, including Denmark (199%), Ireland (191%), and Netherlands
(185%), but lower in others, such as Italy (43%), France (60%), Belgium (64%), and Germany (82%).
From 1997 to 2007, the U.S. household leverage ratio rose by 42 percentage points. Other countries
experienced a greater increase in household leverage over the same period, including Ireland (+85
points), Netherlands (+82 points), Denmark (+69 points), Portugal (+65 points), Spain (+52 points),
United Kingdom (+52 points), and Norway (+50 points). At the other end of the spectrum, leverage
ratios rose only modestly in Austria (+13 points), Belgium (+14 points), and France (+15 points), while
they actually declined in Germany (-2 points) and Japan (-5 points).
Figure 2 plots the trajectory of real
house prices in the United States and
other industrial countries since 1997.
Austria, Belgium, and Portugal are
omitted due to lack of data. Real house
prices in the United States rose by
roughly 50%, reaching a peak in 2006.
House prices in other industrial
countries also rose substantially and in
most cases more than in the United
States. At their peaks, prices rose the
most in Ireland (172%), United
Kingdom (146%), Spain (118%), and
France and Sweden (108%), followed
by Denmark, (89%), Netherlands
(75%), and Italy (61%). These dramatic
run-ups, which far exceeded the
growth in disposable incomes over the
same period, show that housing
bubbles were widespread. The two
exceptions were Japan and Germany,
where real house prices fell over this
period. However, both countries had
previously experienced large run-ups
in house prices during the late 1980s
and early 1990s.
Figure 3 combines data from Figures 1
and 2. The scatter plot shows that
countries exhibiting the largest
increases in household leverage from
1997 to 2007 also tended to experience
the fastest rise in house prices over
same period. The pattern suggests that
the link between easy mortgage credit
and rising house prices held on a
global scale.
Figure 2
Real house prices, 1997-2008
Note: All series are indexed to 100 in 1997 except Finland, which
is indexed
to 100 at 2001.
Figure 3
Household leverage and the run-up in house prices
Note: The plotted line depicts the best fit relationship in the data as
generated by a simple least square statistical regression.
0
50
100
150
200
250
300
97 98 99 00 01 02 03 04 05 06 07 08 09
Index
FIN
FRA
GE
R
ITA
JPN
NDL
NOR
SPNSWE
UK
US
DEN
IRL
DEN
FIN
FRA
GER
ITA
IRL
JPN
NLD
NOR
SPA
SWE
UK
US
-50
0
50
100
150
200
-20 0 20 40 60 80 100
% change in house prices, 1997-2007
% point change in household leverage, 1997-2007
FRBSF Economic Letter 2010-01 January 11, 2010
4
Figure 4 shows that countries
experiencing the largest increases in
household leverage before the crisis
tended to experience the most severe
recessions, where severity is measured
by the percentage decline in real
consumption from the second quarter
of 2008 to the first quarter of 2009.
Consumption fell most sharply in
Ireland (-6.7%) and Denmark (-6.3%),
both of which saw huge increases in
household leverage prior to the crisis.
Consumption was flat or fell only
slightly in Germany, Austria, Belgium,
and France, which were among the
countries that saw the smallest
increases in household leverage before
the crisis. Overall, the data suggest that
recession severity in a given country reflects the degree to which prior growth was driven by an
unsustainable borrowing trend. Of course, other factors besides leverage could have influenced the post-
crisis consumption pattern. These include actions taken by policymakers in the respective countries to
mitigate the economic fallout from the financial crisis.
Interestingly, King (1994) identifies a similar correlation between prior increases in household leverage
ratios and the severity of the early 1990s recession using data for 10 major industrial countries from
1984 to 1992. Reviewing earlier historical episodes, he also notes that U.S. consumer debt more than
doubled during the 1920s—a factor that probably contributed to the severity of the Great Depression in
the early 1930s.
Conclusion
Going forward, the efforts of households in many countries to reduce their elevated debt loads via
increased saving could result in sluggish recoveries of consumer spending. Higher saving rates and
correspondingly lower rates of domestic consumption growth would mean that a larger share of GDP
growth would need to come from business investment, net exports, or government spending. Debt
reduction might also be accomplished via various forms of default, such as real estate short sales,
foreclosures, and bankruptcies. But such deleveraging involves significant costs for consumers, including
tax liabilities on forgiven debt, legal fees, and lower credit scores.
As countries begin to emerge from the recession, it is important to consider what lessons might be
learned for the conduct of policy. History suggests that asset price bubbles can be extraordinarily costly
when accompanied by significant increases in borrowing. During the recent housing bubble,
underwriting standards were weakened and credit extension rose at abnormally high rates, creating a
self-reinforcing feedback loop that drove house prices upward. In the aftermath of a global boom-and-
bust cycle in credit and housing, financial regulators should take the necessary steps to prevent a replay
of this damaging episode.
Figure 4
Household leverage and the decline in consumption
Note: The plotted line depicts the best fit relationship in the data as
generated by a simple least square statistical regression.
JPN
GER AUS
BEL
FRA
ITA
US
FIN
SWE
SPA
UK
NOR
POR
IRL
DEN
NLD
-8
-6
-4
-2
0
2
-20 0 20 40 60 80 100
% change in consumption, 08Q2-09Q1
% point change in household leverage, 1997-2007
1
FRBSF Economic Letter 2010-01 January 11, 2010
Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco or of the Board of Governors of the Federal Reserve System. This publication is edited by Sam Zuckerman and Anita
Todd. Permission to reprint portions of articles or whole articles must be obtained in writing. Please send editorial comments and
requests for reprint permission to Research.Library.sf@sf.frb.org.
Reuven Glick is a group vice president in Economic Research at the Federal Reserve Bank of San
Francisco.
Kevin J. Lansing is a senior economist in Economic Research at the Federal Reserve Bank of San
Francisco.
References
Fischer, Irving. 1933. “The Debt-Deflation Theory of Great Depressions.” Econometrica 1, pp. 337-357.
Glick, Reuven, and Kevin J. Lansing. 2009. “U.S. Household Deleveraging and Future Consumption Growth.”
FRBSF Economic Letter 2009-16 (May 15).
http://www.frbsf.org/publications/economics/letter/2009/el2009-16.html
King, Mervyn. 1994. “Debt Deflation: Theory and Evidence.” European Economic Review 38, pp. 419-445.
Mian, Atif, and Amir Sufi. 2009a. “The Consequences of Mortgage Credit Expansion: Evidence from the U.S.
Mortgage Default Crisis.” Quarterly Journal of Economics, forthcoming.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1072304
Mian, Atif, and Amir Sufi. 2009b. “Household Leverage and the Recession of 2007 to 2009.” University of
Chicago, Booth School of Business Working Paper.
https://www.imf.org/external/np/res/seminars/2009/arc/pdf/mian.pdf
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2009-36 Linkages between Monetary and Regulatory Policy:
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y
http://www.frbsf.org/publications/economics/letter/2009/el2009-35.html Chehal / Trehan
2009-34 Inflation Expectations and the Risk of Deflation
http://www.frbsf.org/publications/economics/letter/2009/el2009-34.html Christensen
2009-33 Recent Developments in Mortgage Finance
http://www.frbsf.org/publications/economics/letter/2009/el2009-33.html Krainer
2009-32 Gauging Aggregate Credit Market Conditions
http://www.frbsf.org/publications/economics/letter/2009/el2009-32.html Lopez
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The Debt-Deflation Theory of Great Depressions
  • Irving Fischer
Fischer, Irving. 1933. "The Debt-Deflation Theory of Great Depressions." Econometrica 1, pp. 337-357.
University of Chicago, Booth School of Business Working Paper
  • Atif Mian
  • Amir Sufi
Mian, Atif, and Amir Sufi. 2009b. "Household Leverage and the Recession of 2007 to 2009." University of Chicago, Booth School of Business Working Paper. https://www.imf.org/external/np/res/seminars/2009/arc/pdf/mian.pdf Recent issues of FRBSF Economic Letter are available at http://www.frbsf.org/publications/economics/letter/ 2009-38 Bank Relationships and the Depth of the Current Economic Crisis http://www.frbsf.org/publications/economics/letter/2009/el2009-38.html