We Need to Talk About Debt

Pre-recession, the major narrative was that American households were spending too much and saving too little. Now, we’re saving again, and household debt burdens have declined to their lowest rates in over a decade. Well, pat ourselves on the back; we’re finally getting our fiscal cards in order and setting ourselves on the path to recovery, right?

Unfortunately, it’s not that simple. Our increased thriftiness is not necessarily a sign of changed attitudes and behaviors (although rising frugality has played a role), as much as changed circumstances. Defaults on mortgages and other loans in the aftermath of the recession have removed many debts from household balance sheets. The easy credit of the early 2000s—offering 18 year-olds free t-shirts and pizza in exchange for opening a credit card account, for example—has ended. And, unemployment and declining wages have reduced the creditworthiness of many households. While overspending used to draw calls for concern, now economists worry about consumer spending being too low to successfully spur a recovery.

Just as too much debt is cause for concern, too little debt can also be problematic, and highlights the complexity of debt. We know what debt is—money owed to others—but what debt means is more slippery: Is it good, bad, or somewhere in between? Does it mean the same thing for everyone? Does its meaning stay the same or change over time?

Pre-recession, the consensus seemed to be that people were spending too much and if they just stopped buying stuff that they didn’t need, then we wouldn’t have any of these problems! While I agree that consumer society and overconsumption played a role in the broad patterns of American indebtedness, arguing that debt is merely driven by overconsumption is a simplistic theory that lays the blame entirely at the feet of the individual and ignores larger patterns of rising inequality and labor market risks that made households increasingly vulnerable to economic crises. It is hard to criticize a family for “overconsuming” if they lose their job and need to use a credit card to put groceries on the table or pay for their utility bill. The alternative of going hungry or falling into delinquency may do more damage to both immediate and long-term well-being than indebtedness.

The appeal of a simple theory, however, is clear. When talking about household wealth, we typically define wealth as net worth, or assets minus debts. Since assets, much like income, are good, and the more the better, debt must be bad, right? Again, it’s not that easy. First, to get debt, you typically need to have credit, which, like wealth and income, is universally pretty good. Second, debt is often thought of as “bad” because it requires regular payments that could otherwise be used to pay for daily expenses or save for the future. However, debt, and the ability to borrow, may help a household budget for necessities such as a vehicle or a refrigerator. Smaller, regular payments spread over time may be more manageable than one lump-sum payment, and the amount of interest paid may be well worth the benefit of keeping a larger stock of savings in reserve for emergencies.

Further complicating the issue is that debt can help generate long-term wealth by helping households buy a home or get a college degree (and, theoretically, higher earnings). Few households have the financial means to buy a house or pay for college out of pocket, and mortgages and student loans are the bulk of household debts. But while these loans may initially hold the promise of a better life, the meaning of these debts can change from wealth-building to detrimental depending on trends in the broader economy. Homeowners who found themselves “underwater,” owing more on their mortgages than their home was worth, after the housing collapse and recent college grads unable to find jobs in the current downturn know this all too well.

The ambiguity of debt and its many different meanings make it difficult to fully interpret and respond to aggregate trends. There are no clear guidelines to distinguish “problematic” debt levels from those that are more benign. What is clear, however, is that we cannot simplistically categorize debt as good or bad. Moreover, a nuanced understanding of indebtedness is important, as households face increasingly complicated ways of owing money, with a wide range of consequences for their long-term economic well-being.