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Consumer, Corporate Debt Undermines Coronavirus Recovery

Before the coronavirus pandemic lockdown, total household debt was more than $1.6 trillion higher than during the previous peak in 2008, increasing to $155 billion in Q1 to total $14.3 trillion, according to data released by the New York Fed.

Previously, the peak had been $12.68 trillion in the third quarter of 2008––the early days of the financial crisis. Mortgage balances comprised the largest component of household debt, with mortgage increasing by $156 billion in the first quarter of $9.71 trillion.

Through the first three months of 2020, debt other than housing remained stable. Student loan balances ballooned another $27 billion to $1.54 trillion, while auto loan debt went up by $15 billion. Credit card balances fell by $39 billion in Q1, in part due to a steep $338 billion decline in March as consumer spending plummeted due to The Great Lockdown.

New York Fed VP Andrew Haughwout said it’s too early to tell if the steep drop in credit card balances was a result of the pandemic. It is critical to note that the latest report reflects a time when many of the economic effects of the COVID-19 pandemic were only starting to be felt,” said New York Fed VP Andrew Haughwout. “We do see a larger-than-expected decline in credit card balances based on past seasonal patterns, but it is too soon to confidently assess its connection to the pandemic.”

The drop in credit borrowing in Q1 might also reflect the Americans were close to maxing out their credit cards before The Great Lockdown. By the start of March, Americans owed nearly $1.1 trillion on credit card debt.

By the end of 2019, total consumer debt stood at 19.3% of nominal GDP––the highest level ever.

Not only are consumers burdened by heavy debt loads, but corporate debt poses a risk to the recovery, as the Federal Reserve warned in its twice-yearly report released on Friday.

The Fed contends debt loads could “amplify the adverse effects of the Covid-19 outbreak.” Billions of dollars worth of investment-grade ($170 billion) and lower-rated ($29 billion) non-financial corporate debt is due by year’s end, according to the report. Tight financing conditions could limit businesses’ ability to refinance that debt, which would likely “intensify the economic effects of the pandemic on the businesses’ employment and investment decisions.”

Corporate debt offerings have skyrocketed as cash-strapped companies take advantage of the Fed’s plan to unfreeze the bond market in mid-March.Economic activity is contracting sharply, and the associated reduction in earnings and increase in credit needed to bridge the downturn will expand the debt burden and default risk of a highly leveraged business sector,” the Fed said.

The Fed also warned that US banks could face “material losses” from households unable to repay debts in the midst of the coronavirus outbreak, as well as significant hits to stocks and other assets “should the pandemic take an unexpected course, the economic fallout prove more adverse or financial system strains remerge.”

Commercial real estate prices are particularly vulnerable, says the Fed, with hospitality and retail sector disruptions “putting the ability of these sectors to make timely mortgage and rental payments into question.”