Financial Planning Blog

The “Bad Bank” episode of This American Life referenced in the recent post “The Economy Explained” featured an interesting conversation with Columbia Business School professor, David Beim. Besides talking about a bank run in ancient Rome (AD 37) and why not loaning out the government bailout money is the right course of action for the less healthy banks to take, Beim showed a striking chart measuring the level of American household debt. Now showing a chart on the radio is generally not effective, but his description of the trends sure caught my attention. (Click here for a shorter version of the story.)

The latter part of this chart, which shows the ratio of household debt to GDP in the US from 1916 to the present, is not surprising. As Beim describes it, “From 2000 to 2008, it just goes, almost a hockey stick, it goes dramatically upward…It hits 100% of GDP.” This sounds bad, but you have to see the rest of the chart to gain the proper perspective. The ratio moves slowly from around 30% of GDP in the late 1930’s to about 50% of GDP in the mid 1980’s. In the latter part of the 1980’s it accelerates above 50% and goes though 70% by year 2000. Then the real hockey stick move to 100% in 2007.

This may be a bit scary, but hardly a shock if you’ve been paying attention the last twenty five years. What is truly sobering, however, is the second peak of the graph off to the left. As it turns out, this ratio of household debt to GDP reached 100% earlier in our history. The year was 1929—the year of the great stock market crash and start of the Great Depression.

Beim goes on to explain, “That chart is the most striking piece of evidence that I have that what is happening to us is something that goes way beyond toxic assets in banks, it’s something that had little to do with mortgage securitization, or ethics on Wall Street, or anything else. It says the problem is us. The problem is not the banks, greedy though they may be, overpaid though they may be. The problem is us. We have over-borrowed. We have been living very high on the hog. We are, our standard of living has been rising dramatically over the last 25 years, and we have been borrowing to make much of that prosperity happen.”

Now I’m not going make too much out of this one piece of data. Even without this amazing coincidence between 1929 and 2007, it just feels right that there would be eventual consequences to the rampant borrowing we used to finance an ever-improving standard of living. Although I won’t try and predict how the rest of the current economic turmoil plays out, I remain optimistic that we will work through this.

The sad thing is this data is the combination of millions of individual families who have borrowed too much and have lived with too little financial margin. Certainly some are victims of difficult circumstances, but others made poor choices and have lived beyond their means. Although as individuals we cannot control the economy as a whole, we do have control over the spending decisions in our homes. I am hopeful that the trials American families go through today will result in a fresh look at our priorities and produce wiser decisions in the future.