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Visualizing the Changes in Debt

e21 | October 4, 2010

We all know that the government’s debt level has grown enormously over the past several years. But here is something you may not have known — in the second quarter of 2010, the total level of government debt (including state, local, and federal debt) surpassed that of non-financial corporate debt. This is the first time in thirteen years that government debt exceeded the value of ordinary corporate liabilities.

(Chart) Total Debt for Businesses and Government

Unsurprisingly, the change is largely driven by huge increases in government debt and spending. As the Fed’s latest Flow of Funds figures document, federal debt levels have grown, at an annualized rate, in the double-digits for the past eight consecutive quarters. For all but two of those quarters, the increase was over 20%.

State and local debt burdens have been increasing as well. Though they fell slightly in the latest quarter, they have increased at a steady pace throughout the crisis

(Table) Growth of Domestic Nonfinancial Debt

A more promising picture comes from the household sector, which has seen modest decreases in debt (even as overall debt burdens continue to rise, largely driven by the federal government). Household debt is now down for nine consecutive quarters, but at a sluggish pace. Both mortgage and credit card debt decreased in the latest quarter, largely driven by defaults rather than belt-tightening.

Though the false promises of a debt-fueled growth binge are now apparent to most, it’s also clear that the American economy has not yet kicked its habit for kicking costs down the road.  Some households are modestly paring back liabilities after a full decade of steep debt increases, but this is occurring largely through charge-offs (i.e. banks writing off the value of credit card or mortgage debt) rather than de-leveraging. And the minor cutbacks by households are more than balanced by large increases in debt in the government sector.

A change to more sustainable patterns of borrowing and spending is essential to avoid future financial crises and build future prosperity. For instance Eddie Lazear’s recent proposal, presented in the Wall Street Journal, envisions that government spending only be allowed to increase at the inflation rate minus 1%.  Mr. Lazear makes the case that this would ensure that the current budget deficit is balanced over the next 10 years. Unfortunately, there is little appetite so far to seriously address the national debt problem. Thus far, we have avoided even more serious financial problems by converting private liabilities into public ones, not by seriously dealing with the core problem of too much debt.