'Recessions usually follow rise in household debt'

Not all household debt is evil, and experts should be wary of the sharp increases over a two to four year period.

Dubai: A large housing boom will often fuel a sharp spike in household debt, and that will almost always lead to a severe recession, noted Professor Amir Sufi.
Speaking at the dunia Knowledge Series, the Bruce Lindsay Professor of Economics and Public Policy at the University of Chicago Booth School of Business, explained that basic research has shown that one of the strongest predictive signs of an economic downturn in any country is a rapid explosion of household debt, usually associated with a housing boom.
"Why was the great recession so severe, and why is it that the world economy having such a hard time generating sustainable, long-term, strong growth? When it comes down to it, very severe recessions typically follow situations in which household debt rises dramatically in a country. If you want to pick out the usual suspects from the great recession, it would be the US, the UK, Ireland, Spain, and Greece. Pick any country that suffered a terrible recession in 2008, 2009 and 2010 and I can tell you with the upmost assurance that they had a big housing boom that fuelled household debt in the preceding years," he said. Sufi, who recently co-authored a book titled 'House of Debt' that explores the 2008 recession, also noted that in 2011, one could immediately start seeing the foundations of very severe economic downturns in many emerging countries. "The usual emerging suspects in emerging economies would be Brazil, Thailand and China to a lesser extent. The exact same story that played out in 2008 and 2009 in developed economies, is now true in emerging economies. If you look at the prediction data issued the World Bank, you can see that the countries that experience the largest increases in debt, are seeing the largest downward trend in their future growth," he said.
However, he was quick to point out that not all household debt is evil, and that experts should be wary of the sharp increases over a two to four year period. "This is what I call credit supply shocks. Banks begin to lend more to households, in particular marginal households that may not have good credit histories, and this typically ends very badly." He also pointed out that research has increasingly shown that monetary policies in the core countries is a key factor.
"When you have loose monetary policies, you tend to see a lot of credit going to households where it shouldn't be headed. When we are looking at the current global circumstance, one of the nice things globally is that the world is on a massive deleveraging move. This is why I would say that I am actually very optimistic about the US."
- rohma@khaleejtimes.com