What caused the Great Recession? The simplest explanation is too much debt. Too many first-time homebuyers bought houses they could not afford; too many homeowners used their bubble-inflated home equity like a piggybank; too many consumers maxed out on their credit cards.
The business and financial sectors engaged in their own debt binges during the 2000s. Too many companies used debt to buy back stock; too many banks made faulty loans; too many hedge funds used other peoples’ money to speculate in derivatives tied to collateralized debt obligations; and too many private equity firms borrowed to buy out companies.
When enough loans go bad, the excesses are exposed, the banks stop lending, and people and businesses reach the end of their credit rope. The bubble bursts. Then the contagion spreads. The only path forward is to stop spending, start paying off old bills and save. The process is known as deleveraging, which historical experience suggests is always longest and most painful after a debt-fueled financial crisis.
Consumers are unlikely to assume their historic posture as spender of last resort for the global economy
The U.S. is now in its fourth year of deleveraging in the wake of the 2007-08 credit collapse. And while there are growing signs that the process has reached the point where consumers can start spending again, a new report from the McKinsey Global Institute says U.S. consumers are unlikely to assume their historic posture as spender of last resort for the global economy.
“They probably won’t be as powerful an engine of global growth as they were before the crisis,” according to the report, Debt and deleveraging: Uneven progress on the path to growth. “One reason is that they will no longer have easy access to the equity in their homes to use for consumption.”
The report estimated that home equity loans and cash-out refinancing increased consumer spending by a percentage point to 3 percent growth a year during the housing bubble years. But with that source of debt financing gone, retailers are more likely to see 2 percent annual growth over the next few years, which is about where it has been in recent months.