Household Debt Didn't Deter Lenders

By Sean Hannon, CFA, CFP, of Covestor.com

Contracting credit should be an aspect of the business cycle. As the economy grows, credit expands, investments are made and price levels rise. Eventually, we reach a point at which prudent lending standards prevent further credit expansion, borrowing stagnates and economic growth either moderates or declines.

During the decline, certain borrowers will experience hardship and default on their loans. If, during the expansion, debt levels remained moderate and loan standards prudent, defaults would be limited and economic damage contained.

Our current crisis is much different. As the credit bubble expanded earlier this decade, household debt grew from 60% of GDP to 97% of GDP. Similarly, household debt as a percentage of disposable income (measured as income after taxes) grew from 89% to 127%. ...