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38 Deleveraging, What Deleveraging
Moreover, it was a private-sector phenomenon, as net government obligations
in relation to nominal GDP moved sideways after the step-up propelled by the
Bush tax cuts. The speed of the ascent is striking. In the five years after 2003,
the ratio of total debt to GDP rose 62 percentage points, led by a 22 percentage
point increase in the debt share of the financial sector and a 12 percentage point
increase by households.
The pullback since has been uneven and in the aggregate pales in significance
compared to the earlier rise, even if there has been more adjustment than in other
regions (such as the Eurozone). To be sure, the financial sector trimmed its sails
with both write-downs and goading from supervisors and regulators, resulting
in a decline in the sector’s debt-to-GDP ratio by about 37 percentage points.
Households and, to a lesser extent, state and local governments also delevered,
with their GDP shares falling 17 percentage points and 2 percentage points,
respectively. Contrary to the widespread perception and self-congratulations of
public officials, the US remains highly levered today as a consequence of a near 38
percentage point increase in federal debt relative to nominal GDP. In addition to
the growing federal deficit, the bailouts of the government-sponsored enterprises
(GSEs), AIG and the auto industry propelled the 50 percentage point increase in
total public debt relative to GDP. 19
The role of the leverage cycle — its surge of self-fulfilling enthusiasm followed
by despair — is seen best in Figure 4.2. The solid line plots the level of US real
GDP per capita in international dollars, while the dashed line plots the level of
real GDP per capita extrapolated from the ten-year trend ending in 2001. There
are two sources of difference between the solid and dashed lines corresponding to
the overestimate of the trend and the lack of recognition of the cyclical position
of the economy. In fact, output was close to its prior trend through 2007, but
the estimated level of potential output was below both trend and actual GDP.
That is, the encouragement to leverage associated with the belief that a high
trend would continue forever pushed aggregate demand into the excess zone.
For a time, headline growth supported that belief even as the foundation to it
was undermined by a slowing in the growth of potential output. Debt taken on
prior to 2007 might have seemed manageable at the time, but that was not the
outcome in the event.
19 The increase in GSE debt is due to accounting for mortgage pools differently after the move of the two
housing-related entities into government conservatorship in 2008.