A sound system of credit is built on collateral. A doomed system of debt sits precariously on phantom collateral.
The global "recovery" is based not on reducing debt but on increasing it. Nice, but where's the collateral? The basic idea of debt is that credit is extended based on collateral, i.e. something of enduring, tradable value, or an income stream that isn't reduced to zero by non-discretionary spending and taxes.
A funny thing happened to collateral like housing equity and financial assets in the past four years--it shrank by trillions of dollars. According to the latest Z1 "Balance Sheet of Households and Non-Profits" from the Federal Reserve, real estate fell by $4.9 trillion since the bubble top in 2007 and owners' equity lost $4.2 trillion.
Despite the stock market doubling since 2009 and a healthy run-up in the value of bonds, financial assets shrank by $2 trillion as well.
These are non-trivial sums when we consider that collateral is generally leveraged. If a home buyer puts down 20% cash, then that cash collateral is leveraged 4-to-1 in an 80% mortgage. If the buyer puts down 3% (as in an FHA loan), then the leverage is over 30-to-1.
Collateral matters when it comes to assessing the value of the debt. If a bank lists the mortgages in its "assets" column at full value even though the underlying collateral (the houses) has lost much of their value, then the bank is grossly over-estimating the value and security of the mortgage. The bank's "assets" are based on phantom collateral.
Take away $1 in collateral and you impair $4, $10, $20 or even $30 of debt.
Recall that the vast majority of real estate equity and financial wealth is owned by the top 20%, with the majority of that concentrated in the top 5%. That means the bottom 80% own little collateral to leverage into debt.
How about leveraging income into more debt? Since the top 10% receive almost 50% of the income, and most of the bottom 90%'s income goes to non-discretionary spending and taxes, then only the top 10% have discretionary income that can be leveraged into more debt.
Interestingly, The Wedge between Productivity and Wages by economist Mark Thoma reports that the enormous advances in productivity over the past few decades did not translate into higher wages for the bottom 90%.
I have often addressed income disparity and the evaporation of collateral, for example,Two Americas: The Gap Between the Top 5% and the Bottom 95% Widens (August 18, 2010) and The Housing Bubble Broke the Middle Class (April 27, 2011).
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