Should we worry about debt rising again?

Household deleveraging, or the paying down of debts, was one of the major economic stories of the recovery from the Great Recession. In the run up to the 2007-2009 recession, household debt doubled between 2001 to 2007 as the housing bubble inflated. The bubble eventually popped and millions of households were left with debt loads they couldn’t handle. Households have been digging out from under this damage in the years since. But according to the data, the period of deleveraging is over. Households now are taking on more debt. And they aren’t alone.

Last month, economists at the Federal Reserve Bank of New York released new data on household debt. The authors say the data show “households have begun to use credit to supplement their cash flow again.” J.W. Mason, a professor at John Jay College, using an accounting approach to household debt finds that the increase in debt-to-income ratio is from new borrowing, opposed to changes in interest rates or inflation.

But households are late to the new borrowing cycle compared to businesses, which have been borrowing considerably for several years now. A new report from the Treasury Department’s Office of Financial Research highlights the increase in corporate leverage.

Now this increase in corporate debt isn’t necessarily a problem. Companies simply could be taking advantage of low-interest rates to borrow and increase their productivity. And for a while, that is what they appeared to be doing, according to the OFR report. But as the authors note that more recently, companies are using the borrowed money for other things.

Instead of growing their businesses, corporations are using borrowed money to buy back stocks, pay out dividends to stockowners, and buy other companies. This means a substantial portion of this borrowed money isn’t used for investment but rather it seems to be used to get profits out of the corporation and into the hands of shareholders. This process might be responsible for the apparent disconnect between corporate profits and investment in recent years.

Furthermore, the OFR report notes the debt issued by corporations is of lower quality that in the past. So called “high-yield” debt has comprised 24 percent of all corporate debt since 2008, compared to 14 percent in previous economic expansions.

Regardless of the reason for borrowing, we should remember that corporations are leveraging up in a period of extraordinarily low interest rates. The Federal Reserve seems ready to raise interest rates in the middle of next year, so the era of zero-interest rates will eventually come to an end. If corporations can adequately handle their debt loads, everything should be fine. But if corporate finances are built on a foundation of sand, requiring future refinancing at higher costs, then we should all be concerned.

This post first appeared on The Washington Center for Equitable Growth

Author: Nick Bunker is a Policy Research Associate with the Washington Center for Equitable Growth.

Image: A man walks past buildings at the central business district of Singapore February 14, 2007. REUTERS/Nicky Loh.