Are We Pushing the Envelope on Debt Loads Again?

In the midst of the greatest U.S. economy in a generation, some people are opting to take out a little insurance.

Despite booming retail sales in spring, Federal Reserve data last week showed that Americans actually paid down their credit card debt in May to the tune of $3.3 billion.

That was the biggest drop in card debt since mid-1980, which was the start of the massive credit crunch that finally broke the back of the super-high 1970s inflation (and broke a lot of households and businesses as well).

Clearly, there is no credit crunch today. While banks have gotten tougher over the last year with some problem credit card holders, money overall is still easy in this economy--a big reason why things are so great.

But the May credit card pay-down, and some other recent developments on the money and credit front, are raising a question that hasn’t been posed much since the early 1990s: Are U.S. debt levels too high--setting a time bomb for the next significant economic slowdown?

Debt, which Wall Street likes to call “leverage” to make it sound less plebeian, often isn’t recognized as a problem until it’s too late.

That was certainly the case in East Asia. Few economists believed a year ago that South Korea or Indonesia had debt problems. Nor could they conceive of the currency devaluations that have since transpired, turning what might otherwise be manageable debt into the equivalent of the San Gabriel mountain range.

America itself has had plenty of nasty experiences with leverage. The stock market crash of 1929 was worsened by the heavy debts incurred in buying stocks “on margin.” In the early 1980s, major U.S. banks came perilously close to failing as huge loans to corrupt Latin

American governments went bad.

In the early 1990s, the twin disasters of excessive commercial real estate lending by banks and S&Ls; and high default rates among junk bond issuers worsened the recession of 1990-1991 and put a drag on the economy for several years.

And while the country has collectively patted itself on the back this year for achieving a balanced federal budget, let’s not forget that it was only a few years ago that Uncle Sam’s deficits were running at $200 billion-plus a year--and the great debate was whether we were bankrupting future generations.

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It’s important to remember that debt isn’t necessarily a bad thing. On the contrary: The modern economy wouldn’t exist without the ability of governments, companies and individuals to use leverage as a tool to facilitate growth and investment.

Problems arise only when lenders allow borrowers to take on too much debt. But by definition, what is “too much” usually isn’t apparent when the debt is being incurred--or the lenders wouldn’t be handing out their money in the first place.

Could the U.S. economy, after seven years of growth, be pushing the envelope in terms of debt loads?

There are some warning signs. The Fed on June 23 said the nation’s commercial banks engaged in “significant” easing of loan terms in 1996 and 1997 as they jockeyed for new business in an intensely competitive lending market. The implication is that banks are allowing higher-risk customers to borrow freely.

What’s more, the Fed specifically cited heavy bank lending to real estate investment trusts as a worry. The REITs have been on a property-buying binge, helping drive commercial real estate prices sharply higher since 1995.

The making of another real estate bust? The bankers, and the REITs, naturally say no. But it’s interesting that REIT shares have tumbled this year despite robust property prices. One wonders if the market is trying to tell us something.

In the market for corporate bonds, meanwhile, Moody’s Investors Service, which rates bond credit quality, downgraded 82 corporate bond issues in the second quarter--the most since 1991.

Also troubling some analysts is that companies have been borrowing at a heady pace from banks. The so-called commercial and industrial bank loan category jumped 12.2% last year alone.

Despite soaring profits since 1994, companies’ need for cash has grown because of heavy merger activity, stock buybacks and capital spending, the Fed noted in a recent report.

Is this re-leveraging of corporate balance sheets troublesome? Not so far, for one big reason: As market interest rates have tumbled in the 1990s, companies have been able to borrow more while paying less. Fed statistics show that U.S. companies’ overall interest costs last year were only about 9% of cash flow--down from more than 20% in the early 1990s.

Likewise, consumers’ debt payments as a percentage of disposable income have plateaued at 17%, up from 15% in 1993 but still below the late-1980s peak of nearly 18%, the Fed says.

It helps that consumers’ demand for installment debt has waned since 1995, thanks in part to rising incomes in the strong economy.

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But even as some consumers opt to pay down credit card debt--perhaps wondering how long the economy’s good times can last--the ebbing of installment loan borrowing has occurred for another reason as well: More people have transferred their debt loads to home equity credit lines, Fed data show.

That’s a smart move, for interest-cost and tax reasons. But it also means more Americans in the 1990s have put their most prized asset--their home--at risk.

How much risk? We won’t know for sure until this great economy isn’t so great anymore. For all sorts of reasons, nobody wants that day to arrive soon.

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Tom Petruno can be reached by e-mail at tom.petruno@latimes.com.

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Credit Growth: A Split Picture

Consumer installment debt on the books of U.S. banks actually declined last year, while corporate borrowing has zoomed. Annual rates of growth for two categories of bank loans:

Commercial and industrial loans

1997: +12.2%

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Consumer loans

1997: --2.2%

Source: Federal Reserve