"Everything in excess is opposed to nature."

—Hippocrates

What Is Private Debt?

If you or your parents have ever borrowed money from a bank or other financial institution to pay for a good or service, then you have participated in a credit market. Such markets exist so that individuals can borrow funds from lenders to make a purchase (such as a television), invest in themselves (such as through training or a college education), or invest in a business. Credit markets play an integral role in matching savers with borrowers. Without credit markets, only those with existing wealth could invest.

When individuals and businesses borrow funds, they accumulate debt. The three most common forms of debt are bonds, loans, and other securitized debt.

• Bonds: A company or government agency can borrow money by selling bonds in a bond market. For example, when the federal government sells a U.S. savings bond, the government receives the money (the price of the bond) immediately and promises to pay the bond holder later, in months or years. That is, the government is borrowing money and the individual or entity who purchases the bond is lending money to the U.S. government. The bond purchaser (lender) then holds the bond as an asset until the debt is paid back with interest by the bond seller.¹ 
• Loans: When a bank or other financial institution lends money to an individual or business, the borrower promises to pay back the amount of the loan with interest.
• Other Securitized Debt: When financial institutions own loans and bonds, they can sell these to others in credit markets. They can even combine various loans and bonds together and sell them as "securitized debt" funds. For example, banks that make mortgage loans often sell the rights to collect the mortgage payments to the government housing agencies, and those agencies² in turn create bonds with payments guaranteed by the payments on the underlying mortgages. Such securities are called mortgage-backed securities, or MBS. 
• Debt is generally categorized into two types: public debt and private debt. Public debt is the debt owed by national, state, and local governments. Private debt is the debt owed by households, businesses, and nonprofits,³ which are also called private nonfinancial entities. Private nonfinancial debt excludes borrowing by the government or financial firms, such as banks. 

Measuring Trends in Private Debt

Figure 1 shows private debt over time as a percentage of U.S. gross domestic product (GDP). GDP measures the value of all new and final goods and services produced in a country in a particular year and is an indicator of the income of that country. Therefore, Figure 1 measures U.S. private debt divided by the U.S. income that generates the ability to pay off that debt. 

Figure 1

Outstanding Debt in Nonfinancial Sectors, Percentage of GDP

NOTE: Includes households, nonprofits, and nonfinancial businesses. Quarterly, seasonally adjusted data. Gray bars indicate recessions as determined by the National Bureau of Economic Research.

SOURCE: Bureau of Economic Analysis and Board of Governors of the Federal Reserve System. FRED^®, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=pGPd, accessed January 2020.

Since the 1950s, total private debt as a percentage of GDP has grown consistently: It passed 100 percent in the early 1980s; accelerated leading up to the financial crisis that started in 2007, when it peaked at over 170 percent; and then decreased to just below 150 percent by 2019. Why has private debt increased as a percentage of GDP? A big factor has been information technology. Computers have made it steadily easier to track people's use of credit and evaluate the likelihood that they will pay off loans.⁴ 

Private vs. Public Debt

The media often discuss the mounting U.S. national debt,⁵ with the national debt of the United States being defined as the public debt and other liabilities of the federal government.⁶ To pay back the public debt, government must raise revenue by taxing citizens. To pay back private debts, households and businesses can either pay lenders out of their incomes or sell existing assets. It's generally undesirable to sell assets, however, especially those needed to generate income, such as a car to get to work or a building to house a business.

At the end of the first quarter of 2019, public loans and debt securities totaled 100 percent of GDP, with federal debt totaling over $18 trillion and contributing 86 percent of the public debt (Table 1).⁷ States and local governments contributed the remaining 14 percent. In that same quarter, private loans and debt securities totaled 148 percent of GDP, with businesses and households each contributing half of the private debt burden. 

When discussing the public debt, the media often ask whether it is too large and when and how it might negatively affect the economy. Less media attention is given to private debt—even though it is at a higher level and can be just as damaging to the economy. Take, for example, mortgage debt, which was an underlying cause of the Great Recession.⁸ In the lead up to the Great Recession, a rapidly growing number of homeowners stopped making mortgage payments and many others defaulted on their loans and lost their homes (discussed more below). Trouble in the mortgage market spread to other markets: Many banks failed, and the ones that survived viewed lending as a riskier proposition in general and were hesitant to offer loans. Therefore, policymakers decided to take action. When the Great Recession began, the Federal Reserve (the central bank of the United States) "acted decisively"⁹ to lend money to banks on a short-term basis at low interest rates in order to provide emergency funds to failing banks and insurance companies, encourage lending, and ensure the proper functioning of the financial system.¹⁰ 

Private Debt Sectors

Home Mortgages

From the early 2000s to 2008, mortgage debt dramatically increased from 45 percent to over 70 percent of GDP (Figure 2) as more and more individuals and families became homeowners. At the time, lending standards had been lowered, allowing for riskier loans—loans to people less likely to have the income or ability to repay their debt. As it turned out, many of these people were ultimately unable to afford their homes, leading to defaults and foreclosures. A widespread decline in house prices also left many people unable or unwilling to make payments on their mortgages, which put the debt securities backed by these mortgages at risk. As many financial firms held MBS, the solvency of these firms was also put at risk and they often declined to make loans to each other or nonfinancial firms. This behavior sparked the Great Recession of 2007-09.

Figure 2

Home Mortgage Debt as a Percentage of GDP

NOTE: Quarterly, seasonally adjusted data. Gray bars indicate recessions as determined by the National Bureau of Economic Research.

SOURCE: Bureau of Economic Analysis and Board of Governors of the Federal Reserve System. FRED^®, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=pD5t, accessed January 2020.

Regarding mortgage risk going forward, there is less concern about a housing market crisis than before the Great Recession: Mortgage credit has steadily decreased since 2009, dropping below 50 percent of GDP as of the third quarter of 2019 (Figure 2). For a discussion of private debt risks that researchers believe could lead to a crisis, see the boxed insert.

Consumer Credit

Consumer credit includes many forms of nonmortgage debt such as credit cards, car loans, student loans, and other credit for the purchase of consumer goods and services. Since the early 1980s, consumer credit has increased from 13 percent of GDP to over 19 percent of GDP (Figure 3). While this is small compared with the overall level of private debt (148 percent in the first quarter of 2019), the failure of any credit market can potentially have a domino effect on other parts of the economy—as was the case for the mortgage market.

Figure 3

Consumer Credit as a Percentage of GDP

NOTE: Quarterly, seasonally adjusted data. Gray bars indicate recessions as determined by the National Bureau of Economic Research.

SOURCE: Bureau of Economic Analysis and Board of Governors of the Federal Reserve System. FRED^®, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=pD5s, accessed January 2020.

Much of the surge in consumer credit in the mid-1990s (Figure 3) can be attributed to the increased use of credit cards for everyday transactions. Two potential areas for concern, however, are the auto and school loan markets.¹¹ In the past 10 years, student loan debt has more than doubled,¹² while the delinquency rate (the percentage of loans with missed or late payments) of auto loans has risen to its highest level since 2012.¹³ 

Business Debt

Companies and businesses borrow funds to invest in the buildings and equipment used to produce goods and services. In general, businesses tend to increase their debts during economic expansions to help the businesses grow (Figure 4). Then, when a recession hits they tend to decrease their debt and cut back on investment or in some cases default (not pay what they owe). Currently, business debt is at an all-time high of 74 percent of GDP (Figure 4), with corporations alone nearing $10 trillion in debt by late 2019.¹⁴ 

Figure 4

Nonfinancial Business Debt Securities and Loans as a Percentage of GDP

NOTE: Quarterly, seasonally adjusted data. Gray bars indicate recessions as determined by the National Bureau of Economic Research.

SOURCE: Bureau of Economic Analysis and Board of Governors of the Federal Reserve System. FRED^®, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=pD5g, accessed January 2020.

Conclusions

The media pays much attention to public debt and whether it negatively affects the economy but much less attention to private debt—debt incurred by households and businesses. Private debt, however, is currently larger than public debt and typically at greater risk for nonpayment. Although all debt levels are relatively high historically, total private debt is currently lower than during the Great Recession. That is, private debt has not increased dramatically as it did in the lead-up to the Great Recession. Debt from auto and student loans has been on the rise in recent years, however, which could be interpreted as a warning sign for our economy.

Notes

¹ For a more detailed discussion of bonds, see the following: Flowers, Barbara. "Financing Businesses and Public Projects with Stocks and Bonds." Federal Reserve Bank of St. Louis Page One Economics^®, October 2016.

² For example, the U.S. Department of Housing and Urban Development is a government housing agency created to encourage home ownership, including for populations for whom home ownership may not otherwise be financially possible. Within this agency, a government corporation called Ginnie Mae guarantees payments on mortgages and MBS created by approved lenders.   

³ Nonprofits organizations include charities, churches, and other organizations that are not permitted to earn a profit from their activities or services.

⁴ Yoo, Peter S. "Still Charging: The Growth of Credit Card Debt between 1992 and 1995." Federal Reserve Bank of St. Louis Review, January/February 1998, 80(1), pp. 19-27.

⁵ For a more detailed discussion of the national debt, see the following: Wolla, Scott A. and Frerking, Kaitlyn. "Making Sense of the National Debt." Federal Reserve Bank of St. Louis Page One Economics®, November 2019.

⁶ The "national debt" of the United States (or any other nation) includes all liabilities, both debt and nondebt. Whereas debts signify a promise to pay back borrowed funds, a nondebt liability signifies a promise to provide future payments or assets in instances where funds were not borrowed. For example, when a business promises to pay its workers for hours already worked, that pending payment is a nondebt liability.

⁷ While federal debt totaled over $18 trillion, the "national debt," which includes nondebt liabilities, was $20.6 trillion in the first quarter of 2019 (Table L.106 Federal Government, Line 16, Z.1 Financial Accounts of the United States, First Quarter 2019, Federal Reserve Statistical Release).

⁸ The Great Recession is the U.S. recession that lasted from December 2007 to June 2009. It also refers to the global decline in economic activity that occurred around the same time.

⁹ Lopez, David A. "Then and Now: Fed Policy Actions During the Great Depression and Great Recession." Federal Reserve Bank of St. Louis Liber8 Economic Information Newsletter, November 2011.

¹⁰ Krugman, Paul. "The 2008 Financial Crisis as Seen from the Top." New York Times, April 16, 2019.

¹¹ Weller, Christian. "In Next Recession, Household Debt Will Feature Big Again." Forbes, July 15, 2019.

¹² Tatham, Matt. "Student Loan Debt Climbs to $1.4 Trillion in 2019." Experian, July 24, 2019.

¹³ Coppola, Gabrielle. "Auto-Loan Delinquencies Are the Highest Since 2012." Bloomberg, February 12, 2019.

¹⁴ Lynch, David J. "Corporate Debt Nears a Record $10 Trillion, and Borrowing Binge Poses New Risks." Washington Post, November 29, 2019.

© 2020, Federal Reserve Bank of St. Louis. The views expressed are those of the author(s) and do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System.