OFF THE CHARTS

Who’s Most Indebted? Banks, Not Consumers

By Floyd Norris

Published: April 4, 2009

FIFTY years after executives at Bank of America had a clever idea — issue credit cards to ordinary consumers — the leveraging of America may finally be over. The amount owed by consumers, in relation to the entire American economy, has started to fall.

But it is not consumers whose willingness to take on debt was most notable during the half-century. It is the financial sector itself. The banks that made the loans proved to be much more willing to borrow than their customers, whether corporate or consumer.

And that debt has not begun to recede, despite Wall Street bankruptcies and widespread efforts by financial firms to reduce their own debts.

At the end of 2008, according to the Federal Reserve Board, total debt in the financial sector came to $17.2 trillion, or 121 percent of the size of the gross domestic product of the United States. That was $1 trillion more than a year earlier, when the total came to 115 percent of G.D.P.

Half a century earlier, the financial sector debt was $21 billion, which came to just 6 percent of G.D.P.

Household debt, by contrast, stood at $13.8 trillion at the end of both 2007 and 2008, allowing the debt as a proportion of G.D.P. to fall to 97 percent from 98 percent.

Peter L. Bernstein, an economist and financial historian, drew attention to that trend last month in his publication “Economics and Portfolio Strategy.” He says he thinks households will choose to continue cutting debt even after the economy begins to recover. Even if they want to keep borrowing, he wrote, “The free and easy days of reckless borrowing from 2000 to 2007 are hardly likely to repeat.”

He added that such a decline in debt would reflect “a sustained reduction in the appetite for consumption, which has been the driving force of growth in the economy over the past 15 years or so.” And that, he said, will “be a powerful drag on economic activity for an indefinite period of time.”

Debt levels of nonfinancial businesses rose during a period of high profits earlier in this decade and kept growing last year. The high levels of debt left some companies ill prepared for the combination of recession and tight credit markets that developed in 2007 and 2008.

Government borrowing has soared over the last year and seems likely to continue doing so as the bailouts grow. But over the longer term, the changes have been minimal. In 1958, the total debt of governments, from the federal level down to the smallest town, came to 60 percent of G.D.P. Half a century later, the proportion was just about the same.

Put another way, in 1958, of every $100 in loans in the country, governments accounted for $44 of the borrowing. At the end of last year, government borrowing accounted for only $17 of each $100, while the proportion borrowed by companies and consumers was far higher.

The changes reflect the rapid changes in the American financial system over those years. Not only did consumer credit become much more widely available, as the Bankamericard became Visa and drew competition from other credit cards, but the ways banks financed their loans also changed.

In 1958, 75 percent of financial sector debt was on the books of traditional financial institutions — banks, savings and loans and finance companies. Now the proportion is 18 percent.

Over the half-century, a myriad of financial products and institutions were created to borrow money and own assets, so that one loan to a consumer could create a myriad of debts as it was bundled into a pool that issued securities to buyers that, in turn, borrowed money to finance their purchases. That created a mound of debts that enhanced profits in good times but left financial institutions vulnerable if the value of their assets began to fall.

One of the major questions of the current financial crisis is how many of those innovations will endure and how much they will be changed. It seems likely that the result will be a contraction of financial sector borrowing, but so far that does not show up in the statistics.