– September 23, 2020

Fallout from Covid-19 and government policies of lockdowns and restrictions continue to wreak havoc on the economy. While much attention is focused on measures of activity and labor market conditions, new data from the Federal Reserve highlight critical developments for the financial side of the economy.

The two most striking points from the second quarter Flow of Funds data are the surge in debt growth for the federal government and nonfinancial corporate sectors and the rebound in household net worth. Total debt across the entire economy rose to $59.3 trillion as of the second quarter. The increase was led by the federal government which saw a jump to $22.5 trillion from $19.6 trillion at the end of the first quarter, a rise of almost $3 trillion or about 15 percent (see first chart). That follows a 2.8 percent gain in the first quarter.  From a year ago, federal government debt is up 21.9 percent and since the end of 2015, debt has surged 48 percent. The federal government now accounts for 37.9 percent of all domestic debt outstanding, a record high.

Nonfinancial corporate debt is up 3.3 percent in the second quarter to $11 trillion following a 5.9 percent rise in the first quarter.  From a year ago, nonfinancial corporate debt is up 11.1 percent (see first chart).

Household debt was essentially unchanged at $16.1 trillion while financial sector debt fell to $17.3 trillion from $17.7 trillion at the end of the first quarter (see first chart). Nonfinancial, noncorporate business, primarily small businesses such as partnerships and limited liability corporations, boosted debt by $245 billion to $6.6 trillion, a rise of 3.9 percent while state and local governments increased debt to $3.1 trillion. All government debt (federal plus state and local) accounts for 43.2 percent of domestic debt outstanding.

Despite the pandemic, restrictive government policies, and the worst economic contraction in history, household net worth rebounded in the second quarter to a new record. Household net worth rose to $118.955 trillion, up from $111.348 trillion in the first quarter and above the previous record of $118.576 trillion at the end of 2019 (see top of second chart).

The rebound was due to an increase in financial assets, led by a recovery in equities, and nonfinancial assets, led by a rise in real estate. Total assets rose to $135.4 trillion ($94.5 trillion of financial assets and $40.9 trillion of nonfinancial assets), a rise of 5.9 percent. On the liabilities side, total household liabilities were essentially unchanged at $16.5 trillion (see top of second chart).

Two key measures suggest that household balance sheets are generally healthy, though the fallout from the recession, lockdowns, and weak labor market are likely to harm households over coming quarters. As of the second quarter, total household liabilities to assets were 12.2 percent, down from 12.9 percent at the end of the first quarter and near a four-decade low (see bottom of second chart). Data through the first quarter (second quarter data should be available next week) show household debt service is also near multidecade lows as the financial obligations ratio, debt payments as a share of disposable income, was 15.0 percent (see bottom of second chart).

Nonfinancial corporate balance sheets appear far less healthy than households. Nonfinancial corporate debt has been rising rapidly over the past decade, generally posting annual increases in the five to ten percent range. As of the second quarter, nonfinancial corporate debt totaled $30.7 trillion, up from $28.9 trillion at the end of the first quarter and $28.5 trillion at the end of the second quarter 2019, a rise of 7.9 percent (see top of third chart). Assets meanwhile posted a 4.1 percent gain from a year ago, totaling $46.5 trillion (see top of third chart). Those results put the ratio of liabilities to assets at 66 percent, a new record high (see bottom of third chart). While low rates make servicing debt easier, and Fed intervention in broader capital markets may ease some liquidity issues, high levels of nonfinancial corporate debt are a very dangerous development given the state of the economy.

Of all the sectors in the domestic economy, the financial position of the federal government is the most troubling. Total public debt outstanding is up to 107.7 percent of gross domestic product as ongoing deficits run around $3 trillion (see fourth chart).

Managing debt has been a challenge for all sectors of the economy at different times in history. Inevitably, excessive debt creates instability and can drive or contribute to boom-bust cycles. Debt management across all sectors should be monitored carefully.

Robert Hughes

Bob Hughes

Robert Hughes joined AIER in 2013 following more than 25 years in economic and financial markets research on Wall Street. Bob was formerly the head of Global Equity Strategy for Brown Brothers Harriman, where he developed equity investment strategy combining top-down macro analysis with bottom-up fundamentals. Prior to BBH, Bob was a Senior Equity Strategist for State Street Global Markets, Senior Economic Strategist with Prudential Equity Group and Senior Economist and Financial Markets Analyst for Citicorp Investment Services. Bob has a MA in economics from Fordham University and a BS in business from Lehigh University.

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