McKinsey - Del Ever Aging Jan 2012

8/3/2019 McKinsey - Del Ever Aging Jan 2012

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Updated research

McKinsey Global Institute

Debt and deleveraging:Uneven progress on thepath to growth

January 2012


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Copyright McKinsey & Company 2012

Te MKie G Ititte

The McKinsey Global Institute (MGI), the business and economics research

arm o McKinsey & Company, was established in 1990 to develop a deeper

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aecting business strategy and public policy. MGIs in-depth reports have

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Updated research

Charles RoxburghSusan Lund

Toos DaruvalaJames ManyikaRichard DobbsRamon FornKaren Croxson

January 2012

Debt and deleveraging:Uneven progress on thepath to growth


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In 2011, the global economy continued to ee l the lingering eects o the 2008

nancial crisis. For those hoping to see progress on reducing the debt overhang

rom the credit bubble and a stronger economic recovery, it was a year o

disappointment and resh dangers.

Two years ago, the McKinsey Global Institute (MGI) published a report that

examined the global credit bubble and looked at 32 episodes in which countries

had signicantly reduced the ir debtor deleveragedater a nancial crisis. In

that research, Debt and deleveraging: The global credit bubble and its economic

consequences, we warned how long and painul the process o reducing debt

would be.

In this report, we update that research and assess the progress in deleveraging

by the major mature economies today. We ocus particularly on the United States,

the United Kingdom, and Spain, three large economies in which the credit bubble

was pronounced. These nations are acing a range o challenges that illustrate

the dicult trade-os involved in stabilizing nancial systems, reducing debt, and

restarting growth.

We also examine more closely the banking crises and deleveraging episodes oSweden and Finland in the 1990s, which oer relevant lessons or debt reduction

today. We see that these Nordic deleveraging episodes proceeded in two

phasesseveral years o private-sector debt reduction and recession, ollowed by

a longer period o economic expansion and public-sector deleveraging. It is our

hope that by looking deeply into how todays economies are progressing through

these phases, business leaders and policy makers can gain a bet ter perspective

on what to expect and how to crat policies and strategies or a deleveraging

environment.

McKinsey Global Institute leaders Charles Roxburgh and Susan Lund directed

this research. McKinsey directors James Manyika, Richard Dobbs, Toos Daruvala,and Ramon Forn provided support and insight. The project team was headed by

Karen Croxson and included Alber t Bollard, Dennis Bron, and John Piotrowski.

We thank Georey Lewis or editorial suppor t, and other members o the MGI

communications and operations organization or their many contributions: Julie

Philpot, Deadra Henderson, Tim Beacom, and Rebeca Robboy.

The analysis and insights in this report also refect the generous contributions o

McKinsey colleagues rom around the world: Per-Anders Enkvist, Enrique Garcia

Lopez, Sara Jonsson, Carmen Martin Ruiz-Jarabo, Jaana Remes, Olli Salo, and

Annaliina Soikkanen. We are also grateul to David Hunt, a ormer McKinsey

colleague and now CEO o Prudential Investment Management.

Preace


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Debt and deleveraging: Uneven progress on the path to growth


We wish to thank several academic experts whose knowledge and guidance

helped shape this report: Martin N. Baily, Bernard L. Schwartz Chair in Economic

Policy Development at the Brookings Institution; Klas Eklund, senior economist at

SEB and adjunct proessor o economics, University o Lund; and Matti Pohjola,

proessor o economics, Aalto University School o Economics and ormer

deputy di rector o the United Nations Universi tyWorld Institute or Development

Economics Research (UNU-WIDER).

Our goal is to develop a clearer understanding o how economies can reduce

debt and resume economic growth in an orderly way and provide some useul

markers o progress or policy makers and business leaders. As with all MGI

projects, this research is independent and has not been commissioned or

sponsored in any way by any business, government, or other institution.

Richard Dobbs

Director, McKinsey Global Institute

Seoul

James Manyika


San Francisco

Charles Roxburgh


London

Susan Lund

Director o Research, McKinsey Global Institute

Washington, DC

January 2012


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Executive summary 1

Debt and deleveraging: Uneven progress on the path to growth 11

Appendix: Technical notes 43

Bibliography 51

Contents


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1

The deleveraging process that began in 2008 is proving to be long and pa inul,

just as historical experience suggested it would be. Two years ago, the McKinsey

Global Institute published a report that examined the global credit bubble and

provided in-depth analysis o the 32 episodes o debt reduction ollowing nancial

crises since the 1930s.1 The eurozones debt crisis is just the latest reminder o

how damaging the consequences are when countries have too much debt and

too little growth.

In this report, we revisit the worlds ten largest mature economies2 to see where

they stand in the process o deleveraging. We pay par ticular attention to the

experience and outlook or the United States, the United Kingdom, and Spain, a

set o countries that covers a broad range o deleveraging and growth challenges.

We also look at the relevant lessons rom history about how governments can

support economic recovery amid deleveraging. We discuss six markers that

business and government leaders can look or when monitoring progress, and

we assess how close to these milestones the United States, the United Kingdom,

and Spain are today. Among our key ndings:

The deleveraging process is in its early stages in most countries. Total debt

has actually grown across the worlds ten largest mature economies since the200809 nancial crisis, due mainly to rising government debt. Moreover, the

ratio o total debt to GDP has declined in only three countries in our sample:

the United States, South Korea, and Australia (Exhibit E1).

The deleveraging episodes o Sweden and Finland in the 1990s are

particularly relevant today. They show two distinct phases o deleveraging.

In the rst, households, corporations, and nancial institutions reduce debt

signicantly over several years, while economic growth is negative or minimal

and government debt rises. In the second phase, growth rebounds and

government debt is reduced gradually over many years.

Today, the United States most closely ollows this debt-reduction path. Debt in

the nancial sector relative to GDP has allen back to levels last seen in 2000,

beore the credit bubble. US households have reduced their debt relative to

disposable income by 15 percentage points, more than in any other country;

at this rate, they could reach sustainable debt levels in two years or so.

Deleveraging in the United Kingdom and Spain is proceeding more slowly.

The ratio o UK debt to GDP has continued to rise and UK households have

increased debt in absolute terms. In Spain, households have barely reduced

debt ratios and corporations continue to carry the highest level o debt relative

1 Debt and deleveraging: The global credit bubble and its economic consequences, McKinsey

Global Insti tute, January 2010 (www.mckinsey.com/mgi).

2 The list comprises, in descending order by GDP: the United States, Japan, Germany, France,

the United Kingdom, Italy, Canada, Spain, Australia, and South Korea.

Executive summary


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2

to GDP in our ten-country sample. It could take many more years to nish an

orderly deleveraging in the United Kingdom and Spain.

The Swedish and Finnish deleveraging episodes reveal six critical markers

o progress beore the economic recovery takes o : the nancial sectoris stabilized and lending volumes are rising; structural reorms have been

implemented; credible medium-term public decit reduction plans are in place;

exports are growing; private investment has resumed; and the housing market

is stabilized, with residential construction reviving.

Despite concerns over the strength o its recovery and the protracted debate

over how to reduce public debt, the United States has reached more o these

milestones than other nations and is closest to moving into the second, growth

phase o deleveraging. Still, no country has a ll the conditions in place to revive

growth. For business leaders trying to navigate the new world o debt reduction,

understanding the course o deleveraging is o critical importance. Although

growth in the time o deleveraging may be slower and more volatile in some

countries, there are also clear opportunities to invest ahead o demand and

exploit pockets o growth even within slowly expanding economies.

Eiit E1

550

500

450

400

350

300

250

200

150

100

0

Q2

2011

080604022000989694921990

SOURCE: Haver Analytics; national central banks; McKinsey Global Institute

1 Includes all loans and fixed-income securities of households, corporations, financial institutions, and government.2 Defined as an increase of 25 percentage points or more.

3 Or latest available.

Deleveraging has only just begun in the ten largest

developed economiesTotal debt,1 1990Q2 2011

% of GDP

Canada

Australia

Germany

United States

South Korea

Italy

France

Spain

United Kingdom

Japan

Change

Percentage points

2000

08

2008

Q2 20113

Significant increase

in leverage2

Deleveraging

75

39

7

37

177

89

145

68

91

77

-16

17

1

39

20

35

26

12

-16

-14


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3Debt and deleveraging: Uneven progress on the path to growthMcKinsey Global Institute

ThE paTh To dElEvEraGInG: a TalE of ThrEE counTrIEs

In our previous work on debt and deleveraging, we studied 32 episodes o debt

reduction ollowing nancial crises. We nd that the experiences o Sweden and

Finland in the 1990s oer case examples or todays deleveraging economies.3 In

the 1980s, both Nordic nations experienced credit booms and housing bubblesthat ended in nancial crises. Starting in 1990, both nations experienced severe

recessions, as private-sector debt was reduced and government debt rose

sharplydoubling in Sweden and tripling in Finland. But these countries moved

decisively to resolve their nancial crises and enacted reorms to set the stage or

growth. By 1994, GDP growth had rebounded in both countries and a long period

o scal discipline and government deleveraging began (Exhibit E2).

Today, the United States is ollowing the Swedish and Finnish examples most

closely and may be two years or so away rom completing private-sector

deleveraging. The United Kingdom and Spain have made less progress and could

be a decade away rom reducing their private-sector debt to the pre-bubbletrend.

Te uite stte: a igt t te e te te

Since the end o 2008, all categories o US private-sector debt have allen relative

to GDP. Financial-sector debt has declined rom $8 trillion to $6.1 trillion and

stands at 40 percent o GDP, the same as in 2000. Nonnancial corporations

have also reduced their debt relative to GDP, and US household debt has allen

by $584 billion, or a 15 percentage-point reduction relative to disposable income.

Two-thirds o household debt reduction is due to deaults on home loans and

consumer debt. With $254 billion o mortgages still in the oreclosure pipeline,

3 O the 32 episodes, 21 were in emerging markets. Some that occurred in mature economies

predate the modern nancial e ra (e.g., the US ater the Great Depression and the UK a ter

World War II), and others involved high infation, which mechanically reduced the ratio o debt

to GDP (e.g., Spain in 1976).

Eiit E2

Deleveraging typically begins in the private sector, even as government

debt continues to grow

Average of Swedish and Finnish deleveraging episodes

SOURCE: International Monetary Fund; Haver Analytics; McKinsey Global Institute

12 years 46 years ~10 years10 years

Real GDP

Recession

Deleveraging

Early stage

of recession

Private-sector

deleveraging

Pre-crisis

period

Real GDP growth

Annual average (%)

-3% 1% 3%3%

Change in debt/GDP

Percentage points

8 -26 8760

Private debt/

GDP

Private sector

15 21 -303

Public debt/

GDP

Rebound and public-

sector deleveraging

Public sector

Time


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4

the United States could see several more percentage points o household

deleveraging in the months and years ahead as the oreclosure process

continues.

Historical precedent suggests that US households could be as much as halwaythrough the deleveraging process. I we dene household de leveraging to

sustainable levels as a return to the pre-bubble trend or the ratio o household

debt to disposable income, then at the current pace o debt reduction, US

households would complete thei r deleveraging by mid-2013. When we compare

US household progress to the Swedish deleveraging episode, in which the ratio o

household debt to income declined by more than 40 percentage points, we see

that US household deleveraging is a little more than one-third complete. Because

US interest rates today are lower than interest rates were in Sweden during its

deleveraging, US households may be able to sustain somewhat higher levels o

debt (Exhibit E3).

Even when US consumers nish deleveraging, however, they probably wont

be as powerul an engine o global growth as they were beore the crisis. One

reason is that they will no longer have easy access to the equity in their homes

to use or consumption. From 2003 to 2007, US households took out $2.2 trillion

in home equity loans and cash-out renancing, about one-th o which went to

und consumption. Without the extra purchasing that this home equity extraction

enabled, we calculate that consumer spending would have grown about

2 percent annually during the boom, rather than the roughly 3 percent recorded.

This steady state consumption growth o 2 percent a year is similar to the

annualized rate in the third quarter o 2011.

US government debt has continued to grow because o the costs o the crisisand the recession. Furthermore, because the Uni ted States entered the nancial

crisis with large decits, public debt has reached its highest level80 percent

o GDP in the second quarter o 2011since World War II. The next phase o

Eiit E3

SOURCE: Haver Analytics; Statistics Sweden; McKinsey Global Institute

Credit boom Deleveraging

NOTE: 2011 figures are as of Q2 2011.

Spain

(Year 0 = 2007)

United States

(Year 0 = 2008)

United Kingdom

(Year 0 = 2008)

Sweden

(Year 0 = 1988)

Household debt

% of disposable income

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9

90

80

160

150

140

130120

110

100-41 p.p.

-10 p.p.

-6 p.p.-15 p.p.

70

0

US households are about one-third of the way to

the Swedish level of debt reduction

Peak

household

debt

Years


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deleveraging, in which the government begins reducing debt, will require dicult

political choices that policy makers have thus ar been unable to make.

Te uite Kigm: deeegig jt eg

Total UK public- and private-sector debt has risen slightly, reaching 507 percento GDP in mid-2011, compared with 487 percent at the end o 2008 and

310 percent in 2000, beore the bubble. The composition o UK debthow

much is owed by dierent sectors o the economydiverges rom that o other

countries (Exhibit E4). While the largest component o US debt is household

borrowing and the largest share o Japanese debt is government debt, the

nancial sector accounts or the largest share o debt in the United Kingdom.

Although UK banks have signicantly improved their capital ratios, nonbank

nancial companies have increased debt issuance since the crisis. British nancial

institutions also have signicant exposure to troubled eurozone borrowers, mainly

in the private sector. Nonnancial companies in the United Kingdom have reduced

their debt since 2008.

UK household debt, in absolute terms, has increased slightly since 2008. Unlike

in the United States, where deaults and oreclosures account or the majority o

household debt reduction, UK banks have been active in granting orbearance to

troubled borrowers, and this may have prevented or deerred many oreclosures.

This may obscure the extent o the mortgage debt problem. The Bank o England

estimates that up to 12 percent o home loans are in a orbearance process.

Another 2 percent are delinquent. Overall, this may mean that the UK has a

similar level o mortgages in some degree o diculty as in the United States.

Moreover, around two-thirds o UK mor tgages have foating interest rates, which

may create distress i interest rates riseparticularly since UK household debtservice payments are already one-third higher than in the United States.

Eiit E4

The composition of debt varies widely across countries HouseholdsNonfinancial corporations

Financial institutions

Government

SOURCE: Haver Analytics; Bank for International Settlements; national central banks; McKinsey Global Institute

1 Includes all loans and fixed-income securities of households, corporations, financial institutions, and government.

2 Q1 2011 data.

NOTE: Numbers may not sum due to rounding.

Total debt,1 Q2 2011

% of GDP

67

98

82

81

87

105

91

226

81

71

90

111

80

8360

48

2765363

Australia 27759 91 21

Germany 27849 87

United States 2797240

South Korea 314107 93 33

Italy2 31445 82 76

France 346111 97

Spain 363134

Canada

76

United Kingdom 507109 219

Japan 51299 120

10 largest mature economies

124

82

94

85

71

79

111

13262

7

65

Italy2 31445 82 76

Portugal2 356

Greece 267

194 259

128 55

Spain 363134 76

Ireland2 663

Eurozone-crisis countries

69


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6

The United Kingdom thereore does not appear to be ollowing the deleveraging

path o Sweden. At the recent pace o debt reduction, we calculate that the ratio

o UK household debt to disposable income would not return to its pre-bubble

trend or up to a decade. Overall, the United Kingdom needs to steer a dicult

course: reduce government decits and encourage household debt reductionwithout limiting GDP growth. The United Kingdom will need renewed investment

by nonnancial businesses to achieve this.

si: Te g e

The global credit boom accelerated growth in Spain, a country that was already

among the astest-growing economies in Europe. With the launch o the euro in

1999, Spains interest rates ell by 40 percent as they converged with rates o

other eurozone countries. That helped spark a real estate boom that ultimately

created 5 million new housing units over a period when the number o households

expanded by 2.5 million. Corporations dramatically increased borrowing as well.

As in the United Kingdom, deleveraging is proceeding slowly. Spains total debt

rose rom 337 percent o GDP in 2008 to 363 percent in mid-2011, due to rapidly

growing government debt. Outstanding household debt relative to disposable

income has declined just 6 percentage points. Spain also has unusually

high levels o corporate debt: the ratio o debt to national output o Spanish

nonnancial rms is 20 percent higher than that o French and UK nonnancial

rms, twice that o US rms, and three times that o German companies. Part

o the reason or Spains high corporate debt is its la rge commercial real estate

sector, but we nd that corporate debt across other industries is higher in Spain

than in other countries. Spains nancial sector aces continuing troubles as

well: the Bank o Spain estimates that as many as hal o loans or real estatedevelopment could be in trouble.4

Spain has ewer policy options to revive growth than the United Kingdom and

the United States. As a member o the eurozone, it cannot take on more public

debt to stimulate growth, nor can it depreciate its currency to bolster its exports.

That leaves restoring business condence and under taking structural reorms to

improve competitiveness and productivity as the most important steps Spain can

take. Its new government, elected in late 2011, is putting orth policy proposals to

stabilize the banking sector and spur growth in the private sector.

GrowTh In ThE TIME of dElEvEr aGInGWe see rom the experience o Sweden and Finland that economies that succeed

in restoring growth ater deleveraging share certain characteristics. In these

nations, we see six critical markers o progress that business and government

leaders can look or when they evaluate how todays deleveraging economies are

progressing and what priorities to emphasize. Without these conditions, growth

and public-sector deleveraging are unlikely, as illustrated by Japan, which did not

reach these markers and has suered two decades o slow growth and rising

debt since its 1990 crisis.

4 This gure is mainly loans to real estate developers and does not apply to home mortgages,

where the rate o nonperorming loans is relatively low. Under the Bank o Spains denition,

troubled loans include nonperorming loans, substandard loans (loans that are perorming but

are considered at risk o not perorming), and oreclosures.


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1. I te kig tem te?

In Finland and Sweden, banks were recapitalized and some were nationalized,

and the government set up special institutions to take over and dispose o

the bad loans that clogged the nancial system. This decisive resolution o

the banking crises was critical to kick-starting lending during the growthphase o deleveraging. By contrast, in Japan, ailure to recognize and resolve

nonperorming loans in the corporate sector weighed on Japanese banks or

more than a decade.

In response to the crisis, the United States and the United Kingdom moved

quickly to provide liquidity and capital to banks, and they orced mergers and

nationalized banks where needed. But vulnerabilities remain. In most parts o

the United States, the housing market is still depressed, limiting the mortgage

origination business. The UK nancial sector is heavily exposed to the euro crisis,

with $359 billion in loans to private and sovereign borrowers in troubled eurozone

countries. Spain shut some regional banks, but only recently began discussing amore comprehensive plan to deal with the large number o troubled loans that its

banks hold.

As the euro crisis continues, orced deleveraginga rapid contraction in bank

lending driven by acute unding and capital shortagesremains a risk or all o

Europe. To date, access to bank lending has not been an issue in most o Europe,

primarily because demand or business credit has been weak since 2008. The

eurozone crisis, however, raises the risk o a credit contraction in 2012 i banks

ace unding constraints at the same time they ace rising capital requirements.

Such a orced deleveraging would signicantly damage the regions ability to

escape recession.

2. Is there a credible plan for long-term scal sustainability?

Moving too soon and too aggressively to cut government spending can slow

the recovery, as Finland ound in 1992. But it is also important or governments

to demonstrate a commitment to addressing government debt. In Sweden,

the Social Democratic Party campaigned on a plat orm o scal reorm and

won election in 1994. Through budget restraint and renewed growth, Sweden

eliminated its scal decit by 1998. Government debt ell rom 82 percent o GDP

in 1998 to 45 percent a decade later.

Todays deleveraging economies ace a more dicul t situation. Sweden wasrunning government surpluses when its crisis hit, while the United States and

the United Kingdom were already posting widening decits prior to the nancial

crisis in 2008. In the past two years, the UK and Spanish governments have

adopted austerity plans. The UK program to limit government spending is

credited with keeping government borrowing rates very low, but the impact o

austerity on the strength o the recovery remains a subject o debate. In Spain,

despite a commitment to cut the scal decit to 4.4 percent o GDP by 2012 (rom

11 percent in 2009), rates on government bonds have continued to rise. In 2011,

Spain took the additional step o adopting a constitutional amendment requiring

a balanced budget by 2020. The United States, by contrast, has ailed to adopt

a long-term plan to reduce the ederal dec it, leading to the rst credit ratingdowngrade o US government debt.


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3. ae tt em i e?

Sweden and Finland enacted signicant structural reorms that helped clear the

path to stronger recovery and sustainable growth. The most sweeping change

was joining the European Union in 1995, which allowed both nations to attract

more oreign investment and boost exports. In addition, they enacted reorms toraise productivity and spur growth in sectors such as retail and banking. Japan,

by contrast, did not adopt structural reorms, resulting in a two-tier economy

with some highly productive, export-oriented companies but many small, less

productive rms in domestic sectors.5

Todays deleveraging economies need reorms tailored to their own

circumstances. The United States, or instance, could encourage growth by

investing in inrastructure and workorce skills, streamlining regulatory approvals

or business investment, and simpliying the corporate tax code.6 UK planning

and zoning rules can be reviewed to enable expansion o successul high-growth

cities and to accelerate home building. Inrastructure improvement and continuingto allow immigration o skilled labor can help ensure that the United Kingdom

remains attractive to multinational companies.7 Spain can drastically simpliy

business regulations to ease the ormation o new companies, help improve

productivity by promoting the creation o larger companies, and reorm labor

laws.8

4. ae et iig?

From 1994 to 1998, Swedish and Finnish exports grew by 9.7 percent and

9.4 percent a year, respectively, helping lit these economies into the second

phase o economic growth and public-sector deleveraging. This boom was aided

by a small group o strong export-oriented companies, including Finlands Nokia,whose success in the 1990s generated 25 percent o Finnish exports. Currency

depreciations o up to 34 percent during the crisis also helped boost exports.

In larger economies, such as the United States and the United Kingdom, exports

alone do not have the same potential to drive GDP growth. However, they are

important contributors to rebalancing growth away rom consumer spending.

Service exports, including the hidden ones generated by tourism, are a potential

source o urther export growth. Both nations also have a competitive advantage

in business services, as evidenced by trade surpluses in those sectors. In Spain,

increasing goods exports and tourism will be critical.

5. I ite ietmet iig?

A revival o private investment contributed to GDP growth in Finland and Sweden

and helped oset more moderate consumption growth during the second

phase o deleveraging. In both countries, investment grew at twice the rate o

5 See Why the Japanese economy is not growing: Micro barriers to productivity growth,

McKinsey Global Institute, July 2000 (www.mckinsey.com/mgi).

6 See Growth and renewal in the United States: Retooling Americas economic engine,

McKinsey Global Institute, February 2011; andGrowth and competitiveness in the United

States: The role o its multinational companies, McKinsey Global Institute, June 2010. Both are

available at www.mckinsey.com/mgi.

7 See From austerity to prosperity: Seven prior ities or long-term growth in the United Kingdom,

McKinsey Global Institute, November 2010 (www.mckinsey.com/mgi).

8 SeeA growth agenda or Spain, McKinsey & Company and FEDEA, December 2010.


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consumption during the recovery, and in Sweden investment grew nearly as ast

as exports, albeit rom a very low level during the recession.

Both business and real estate investment declined sharply during the credit

crisis and the ensuing recession in the United States, the United Kingdom, andSpain. In the United States and the United Kingdom, private business investment

declined by roughly one-third during the crisis, and US residential real estate

investment plummeted by twice that amount.

Since the end o the crisis, growth in business investment has remained weak in

all three economies, and companies in the United States and the United Kingdom

have been adding to cash reserves. As long as the business sector continues

to save rather than invest, the strong economic growth that was the biggest

actor in reducing government decits in Sweden and Finland will not materialize.

Thereore, a critical policy goal must be to rebuild business condence and create

the conditions in which executives are willing to invest.

Additionally, given current very low interest rates in the United Kingdom and the

United States, this would be a good time or private investment in inrastructure,

another important enabler o long-term growth. There are ample opportunities to

renew the aging energy and transpor tation systems in both countries, provided

that pricing and regulatory structures are in place to generate reasonable returns.

Spain, too, has opportunities or inrastructure investment.

6. h te ig mket tiize?

A stabilized housing market and a rebound in construction are important

elements in returning to normal economic conditions. Residential real estate

construction equaled between 4 and 5 percent o GDP in the United States

beore the housing bubble, and housing drove sales o durable goods and other

consumer products. Today, the number o US housing star ts is only one-third o

the long-term average, and home prices continue to decline in many parts o the

country.

While the United States has a glut o unsold houses, the United Kingdom is in

need o new homes, thanks to low investment in housing beore the crisis ( just

3.5 percent o GDP, compared with 6 percent in France and Germany and as

much as 12 percent in Spain). Land use rules that prevent many tracts rom being

developed should be reviewed to address the housing shortage.

In Spain, the legacy o the housing boom is more than 1.5 million excess homes.

This inventory could take a decade or longer to clear and will likely weigh on

property prices and construction employment in the meantime.

fIndInG busInEss opporTunITIEs aMId dElEvEraGInG

Deleveraging has important implications or business executives as they

plan investments and consider geographic and strategic priorities. Current

macroeconomic models do not ully capture the impact o deleveraging on

demand.9 Thereore, standard orecasts must be overlaid with a perspective on

how deleveraging is proceeding in dierent markets. As we have seen, not only

9 See Olivier Blanchard, Giovanni DellAriccia, and Paolo Mauro, Rethinking Monetary Policy,

IMF Sta Positon Note, February 12, 2010; and Gauti B. Eggertsson and Paul Krugman, Debt,

Deleveraging, and the Liquidi ty Trap: A Fisher-Minsky-Koo approach, the Federal Reserve

Bank o New York, November 16, 2010.


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10

does the pace o debt reduction vary across economic sectors and nations, but

it can also vary considerably within states and regions, creating very dierent

demand proles. Finding opportunities will require a very granular approach to

strategy. In this environment, business leaders should:

Expect constrained consumer demand.As consumers continue to

deleverage and rely more on current income than credit to und purchases,

growth in consumer spending will be limited. In many nations, slow housing

starts also will dampen demand in many categories. Current growth rates in

consumer spending may be the new normal or quite some time.

Emphasize value. When they do spend, consumers are likely to be ar more

cautious: impulse purchases are no longer in household budgets, and brand

loyalty may have less infuence than price.

Accelerate productivity improvements. With consumers reluctant to

spend and overall growth tepid, margin pressures will likely increase across

industries. This makes additional productivity gains imperative.

Invest ahead o demand. When private-sector deleveraging concludes,

demand will increase. Depending on which economy, this process may take

several years or more. Companies that invest beore demand picks up will be

in position to gain market share. Oten in slow periods, uture sector leaders

make their moves.

Take a granular view o markets.The ater-eects o the debt crisis are

not spread evenly across mature economies or wi thin them. While Nevada

and Florida struggle under the burden o unsold homes and weak consumerdemand, Texas and New York have returned to pre-crisis levels o economic

output.

Consider new opportunities in public-sector projects.There is enormous

need, particularly in the United States and the United Kingdom, or

inrastructure improvements and other public investmentwhich governments

are not in a position to und by themselves. Investments by the private sector

in such projects may be a solution.

Think long term.As we have seen, there are no quick xes when economies

are recovering rom nancial crises and credit bubbles. Nonetheless, there willbe opportunities or businesses that understand the economic environment.

* * *

Navigating through the time o deleveraging requires an understanding o how

countries can succeed in reducing debt without unduly restraining economic

growth. It is a dicult process, requiring structural changes to raise productivity

and rebalance sources o growth. But history shows that countries that rise to the

challenge can set their economies on a path o sustainable and robust long-term

growth.


19/64



11

Three years ater the start o the global nancial crisis, developed economies

continue to struggle with the atermath o the global credit bubble. To varying

degrees, they are reducing debt and trying to nd a path to sustainable growth.

Two years ago, we published a repor t that assessed the magnitude o the global

credit bubble and examined the 32 episodes o deleveraging ater nancial crises

since the Great Depression.10 The core lesson is that al though the process o

debt reduction is long and painul, nations that successully deleverage do return

to robust long-term growth.

In this report, we revisit the worlds ten largest mature economies11 to see where

they stand in the process o deleveraging. We pay par ticular attention to the

experience and outlook or the United States, the United Kingdom, and Spain,

three countries that stood out or high leverage in the original report and which

today represent a broad range o deleveraging and growth challenges. We also

take a closer look at how countries historically have spurred growth ater a crisis,

and we assess the progress o todays deleveraging economies against this

experience.

The examples o deleveraging in Sweden and Finland during the 1990s have

particular relevance today. Both nations experienced credit bubbles that led toasset bubbles and, ultimately, nancial crises. But both also moved decisively to

bolster their banking systems and deal with debt overhang. Andater painul

recessionsboth nations went on to enjoy more than a decade o strong GDP

growth.

The experiences o the two Nordic economies illustrate that deleveraging

oten proceeds in two stages. In the rst, households, the nancial sector, and

nonnancial corporations reduce debt, while economic growth remains very weak

or negative. During this time, government debt typically rises as a result o higher

social costs and depressed tax rece ipts. In the second phase, economic growth

rebounds and then the longer process o gradually reducing government debtbegins.

These examples illustrate that an economy is ready to resume sustained growth

ater private-sector deleveraging when certain conditions are in place: the

nancial sector is stabilized and lending volumes are rising; structural reorms

are in place to boost productivity and enable GDP growth; credible medium-term

public decit reduction plans have been adopted and restore condence; exports

are growing; private investment resumes; and the housing market is stabilized and

residential construction is reviving.

10 Debt and deleveraging: The global credit bubble and its economic consequences, McKinsey

Global Insti tute, January 2010 (www.mckinsey.com/mgi).

11 This list includes, in descending order by GDP: the United States, Japan, Germany, France,

the United Kingdom, Italy, Canada, Spain, Australia, and South Korea.

Debt and deleveraging: Unevenprogress on the path to growth


20/64

12

Today most developed nations are still in the early stages o deleveraging.

Somewhat surprisingly, given the amount o concern over the US economy, we

nd that the United States is ur thest along in private-sector debt reduction and

closest to beginning the second phase o deleveraging. The remaining obstacles

or its return to growth are its unsettled housing market and its ailure to lay out acredible medium-term plan or public debt reduction.

Deleveraging in the United Kingdom and Spain is proceeding at a slower pace.

The United Kingdom has made controlling the government decit a top priority,

but its private sector has made lit tle progress in debt reduction. Overall, the

United Kingdom maintains a ratio o total debt to GDP that is ar higher than the

average in mature economies. The UK nancial sector accounts or the largest

share o UK debt and remains vulnerable to potential losses rom lending in the

eurozone-crisis countries. Spain not only aces the unresolved a termath o its

real estate bubble, but also has a very high level o corporate leverage and a large

overhang o troubled real estate loans. Spains membership in the eurozone andits large government debt restrict its ability to revive growth through monetary and

scal policy. Undertaking structural reorms to raise productivity will be a priority

or Spain.

In all deleveraging countries, the challenge in the next ew years will be to nd

the correct balance between the need to reduce debt and the need to revive

GDP growth. While clear patterns and markers o success can help guide policy

makers, there is no simple ormula and each nation has unique challenges.

This report is organized as ollows: First we assess how overall debt levels have

evolved among the worlds ten largest economies, as well as in emerging markets

and in some additional European countries.12 Then we look more closely at the

deleveraging process in Sweden and Finland in the 1990s. With this historic

record in mind, we assess the progress made by the United States, the United

Kingdom, and Spain in reducing debt, and we examine what conditions still need

to be in place to revive growth. Finally, we discuss the opportunities or business

leaders to gain an advantage and grow in a time o de leveraging.

Global dEbT: whErE wE sTand now

Across the ten largest economies, private-sector debtdened as the debt o

households, corporations, and nancial institutionshas allen by $1.5 trillion, or

2 percent, rom the peak in 2008. But, as is typical in the atermath o nancialcrises,13 government debt has continued to growby $7.8 trillion,14 or 26 percent,

since 2008. As a result, the total debt o each o these countries has increased

and the ratio o overall debt to GDP has risen in seven o the ten. Debt ratios have

allen in only three o these nations: the United States, South Korea, and Australia

(Exhibit 1).

12 We base our analysis on the ten largest economies: the United States, Japan, Germany,

France, the United Kingdom, Italy, Canada, Spain, Australia, and South Korea. We also

conduct select analyses on several other countries o interest: Greece, Ireland, Portugal,

China, India, Brazil, and Russia.13 See Carmen M. Reinhart and Kenneth S. Rogo, This time is dierent: Eight centuries o

fnancial olly(Princeton, NJ: Princeton University Press, 2009).

14 We measure government debt as the sum o gross outstanding marketable government

debt securities. Some analysts argue that a net debt measure is more appropr iate. See the

appendix or a discussion on the di erent measures o government debt.


21/64


The distribution and composition o debt vary considerably across the ten largest

economies and are important actors or determining how deleveraging may

proceed in the coming years (Exhibit 2).

In Japan, or example, government borrowing is by ar the largest por tion o

national debt, while household debt is below the average or mature economies.

This is largely the legacy o two decades o government spending aimed at

reviving growth ollowing the collapse o a property and stock market bubble in

1990. In the United Kingdom, nancial institutions have a large share o total debt,

while UK households and nonnancial businesses also have above-average levels

Eiit 1

550

500

450

400

350

300

250

200

150

100

0

Q2

2011

080604022000989694921990


1 Includes all loans and fixed-income securities of households, corporations, financial institutions, and government.

2 Defined as an increase of 25 percentage points or more.

3 Or latest available.

Deleveraging has only just begun in the ten largest

developed economiesTotal debt,1 1990Q2 2011

% of GDP

Canada

Australia

Germany

United States

South Korea

Italy

France

Spain

United Kingdom

Japan

Change

Percentage points

2000

08

2008

Q2 20113

Significant increase

in leverage2

Deleveraging

75

39

7

37

177

89

145

68

91

77

-16

17

1

39

20

35

26

12

-16

-14

Eiit 2

The composition of debt varies widely across countries HouseholdsNonfinancial

corporations

Financial

institutions

Government


1 Q1 2011 data.

2 According to Canadas national accounts, household sector includes nonfinancial, non-corporate business.


Total debt of ten largest mature economies, Q2 2011

% of GDP

67

98

82

48

45

81

87

60

105

91

226

81

71

90

111

33

80

83

69

277

87

21

Germany 49 278

279United States

9159

107 93

Italy1 82 31476

Australia

27653 63Canada2

South Korea

72 40

314

France 346111 97

Spain 363134 76

United Kingdom 507109 219

Japan 51299 120


22/64

14

o debt. In the United States, Canada, and Australia, household debt is the largest

component o overall debt. In Canada and Australia, there are concerns about

the high ratio o household debt relative to GDP, even though neither country has

experienced a banking crisis.

The distribution o debt within a class o borrowers also matters. Overall

US household debt relative to GDP is lower than in many other countries.

Nevertheless, a subset o American householdspeople who were only able to

borrow heavily when lending standards were laxnow carry unsustainable debt

burdens.

By itsel, a nations total debt-to-GDP ratio can be an unreliable gauge o debt

sustainability. Among the eurozone-crisis countries in 2011, or example, only

Ireland has very high total debt663 percent o GDP (Exhibit 3). In Greece and

Italy, overall leverage is moderate, but the ratio o government debt to GDP is

notably higher than in other mature countries. Corporations and households in

Spain and Portugal have unusually high ratios o debt to GDP, but these countries

entered the nancial crisis with relatively modest government debt. Despite their

dierences, all ve countries now ace high government borrowing costs due to

their weak growth prospects.15

Today, overall debt levels in emerging markets are ar lower than those in

developed economies,16 although this does not mean that developing nations are

now immune to potential debt issues. While the total debt-to-GDP ratio among

the ten largest advanced economies averaged 348 percent at the end o 2010,

the ratio was 184 percent in China, 148 percent in Brazil, 122 percent in India,

15 Note that the ratio o total debt to GDP is not a measure o sovereign risk: the majority o total

debt in any country is owed not by the government, but by pr ivate borrowers. Many other

actors beyond the ratio o government debt to GDP go into assessing sovereign risk.

16 For more detail on emerging markets, see Mapping global capital markets 2011, McKinsey

Global Institute, August 2011 (www.mckinsey.com/mgi).

Eiit 3

77

62

45

94

82

124

100

132

111

79

71

85Ireland2 663194 259

Spain 363134 76

Portugal2 356128 55

Italy2 31482 76

Greece 26765 7

33982 80

Apart from Ireland, countries associated with the

eurozone crisis do not have high levels of overall debt


1 Average of ten largest mature economies: United States, Japan, Germany, France, United Kingdom, Italy, Canada, Spain,

Australia, and South Korea.

2 Q1 2011 data.


Total debt, Q2 2011

% of GDP

Mature economy

average1

Higher than mature

economy average

Households

Nonfinancial corporations


Government


23/64


and 72 percent in Russia. This in par t refects the state o development o their

nancial systems. Even now, however, there may be unsustainable pockets o

leverage developing in these countries. Lending in China increased by $1.2 trillion

in 2010, a rate o credit growth that raises concerns about the quality o

underwriting and the potential or uture credit losses.17

Two phasEs of dElEvEraGInG

In our research into historic episodes o deleveraging, we see that countries oten

progress through two distinct, yet overlapping, phases o private- and public-

sector deleveraging. Todays deleveraging economies ace what seems to be a

uniquely dicult situation: a weak global economy, banking troubles across many

major economies, and lit tle room or scal maneuvering. Yet, they share many o

the same challenges that aced deleveraging nations in the past.

The way debt reduction played out in Sweden and Finland in the 1990s provides

a useul rame o reerence. In those countries, bank deregulation in the 1980sled to a credit boom and soaring household borrowing, which in turn ueled real

estate and equity market bubbles. In 1990, or dierent reasons in each country,

the bubbles collapsed and their currencies sharply depreciated, sending both

economies into deep recessions.18 They aced enormous challenges, including

the rst attempts to reduce popular social programs and deregulate commercial

sectors such as retail. Ultimately, Sweden and Finland addressed their debt

problems, adopted structural reorms, and went on to experience more than a

decade o robust economic growth.

As economists and other experts we interv iewed have stressed, in the midst

o these Nordic deleveraging episodes, neither policy makers nor businessleaders were certain about the outcome or which measures would lead to the

best results. In hindsight, however, we see that both economies went through

a distinct, initial phase o deleveraging in the private sector, leading to a second

phase o growth and public-sector deleveraging.

During the rst phase o deleveraging, households, corporations, and nancial

institutions all reduced their debt over several yearsa painul period, with li ttle

or no real GDP growth and rising government debt. The ratio o private-sector

debt to GDP declined by about one-ourth. The household portion declined even

more sharply, aided in Sweden by infation: rapidly rising prices drove nominal

GDP growth so that the ratio o household debt to GDP declined without anysignicant reduction in outstanding household debt. This was also a time o

negligible economic growth, in which tax revenues ell and public expenditures

grew to support the economy. As a result, government debt rose sharply, growing

rom 46 percent o GDP to 83 percent in Sweden rom 1990 to 1994, and rom

14 percent to 57 percent o GDP in Finland over the same period (Exhibit 4).

17 Ibid.

18 For more detail on these episodes, see the appendix.


24/64

16

As the economy struggled, policy makers in Sweden and Finland moved

decisively to restructure and/or nationalize their banking sectors. They also

enacted a range o structural reorms to boost productivity and improve the

competitiveness o their economies.

By 1994, economic growth began to rebound, setting the stage or public-

sector deleveraging. In Sweden, the Social Democratic Party came to power on

a platorm that promised to bring government nances under control. Sweden

reduced its annual scal decit rom 7 percent o GDP in 1993 to zero in 1998,

and then gradually began to reduce the level o outstanding public sector debt

relative to GDP (see Exhibit 18 on page 33). Swedens ratio o government

debt to GDP ell rom 84 percent at its peak in 1996 to 45 percent by 2008.

Reviving nominal GDP growth was essential to this process: the absolute amount

o government debt actually remained about the same over this period. O the

39 percentage-point drop in the ratio o government debt to GDP, about 28 points

were the result o real GDP growth. Infationwhich some observers suggest

may be an easier way to reduce government debt than cutting government

expenditurescontributed almost 11 percentage points.

Eiit 4

Deleveraging typically begins in the private sector, even as government

debt continues to growAverage of Swedish and Finnish deleveraging episodes

SOURCE: International Monetary Fund; Haver Analytics; McKinsey Global Institute

12 years 46 years ~10 years10 years

Real GDP

Recession

Deleveraging

Early stage

of recession

Private-sector

deleveraging

Pre-crisis

period

Real GDP growth

Annual average (%)

-3% 1% 3%3%

Change in debt/GDP

Percentage points

8 -26 8760

Private debt/

GDP

Private sector

15 21 -303

Public debt/

GDP

Rebound and public-

sector deleveraging

Public sector

Time


25/64


Finland took a slightly dierent course rom Swedens in the early years. It

attempted to implement scal austerity in 1992,19 beore its economy had

recovered rom a recession that was ar more severe than Swedens. Some

observers believe this at tempt to cut government spending was premature,

contributing to the sharp rise in unemployment and prolonging recovery.20

Finlands economy began growing again in 1994, aided in part by the sharp

devaluation o its currency. It went on to gradually reduce its government debt,

rom 56 percent o GDP in 1995 to 34 percent in 2008. Over this period, the

absolute amount o government debt outstanding actually increased, although

less than nominal GDP did. Faster real GDP growth accounted or more than

two-thirds o the decline in the ratio o government debt to GDP, while infation

contributed the remainder.

ThrEE counTrIEs, dIffErEnT spEEds

In our 2010 report, we identied the private sectors o the United States, the

United Kingdom, and Spain as being most likely to deleverage. Today, we nd

that all three countries have begun to reduce private-sector debt, although at very

dierent speeds and with very dierent results.

Determining how much private sector deleveraging is needed in any country is

dicult. Unlike government debt, where there is signicant empirical evidence

about what constitutes a sustainable debt level,21 no guidelines exist or private-

sector debt. Switzerland, or example has a ar higher ratio o household debt

to GDP than the United States (118 percent versus 87 percent), but there is no

pressure or Swiss households to shed their debt. This is because Swiss lenders

are conservative and most mortgage borrowers have high incomes; the home

ownership rate is only around 35 percent. Moreover, these households havesignicant nancial assets to pay their liabilities i needed.

To assess the uture outlook or private-sector deleveraging, we thereore look

at several measures o debt sustainability. These include comparing the level o

debt and debt service ratios with their pre-crisis trends and measuring progress

in deleveraging against the historic episodes o Sweden and Finland. We nd

that US households may have as little as two more years o deleveraging ahead,

while the United Kingdom and Spain are likely to see many more years o gradual

private-sector deleveraging.

19 In 1992, the ruling Centre Party began a program to trim government decits, but lost the

elections in 1994 to the Social Democratic Party, which then introduced its own austerity

program. See Alberto Alesina, Dorian Carloni, and Giampaolo Lecce, The electoral

consequences o large scal adjustments, NBER Working Paper Number 17655, November

2011.

20 For an examination o this point, see Jaakko Kiander and Pentti Vartia, Lessons rom the

crisis in Finland and Sweden in the 1990s, Empirica, 2011, Volume 38.

21 Ninety percent o GDP has been suggested as the limit or sustainable government debt,beyond which growth slows and risks o nancial cr isis and deault rise. See Carmen M.

Reinhart and Kenneth S. Rogo, This time is dierent: Eight centuries o fnancial olly

(Princeton, NJ: Princeton University Press, 2009); and Stephen G. Cecchetti, M. S. Mohanty,

and Fabrizio Zampolli, The real e ects o debt, Bank or International Settlements Working

Paper Number 352, September 2011.


26/64

18

Te uite stte: a igt t te e te te

From 1990 to 2008, US private-sector debt rose rom 148 percent o GDP to

234 percent (Exhibit 5). Household debt rose by more than hal, peaking at

98 percent o GDP in 2008. Debt o nonnancial corporations rose to 79 percent

o GDP, while debt o nancial institutions reached 57 percent o GDP.

Since the end o 2008, all categories o US private-sector debt have allen

as a percent o GDP. The reduction by nancial institutions has been most

striking. By mid-2011 the ratio o nancial-sector debt relative to GDP had allen

below where it stood in 2000. In dollar terms, it declined rom $8 trillion to

$6.1 trillion. Nearly $1 trillion o this decline can be attributed to the collapse o

Lehman Brothers, JP Morgan Chases purchase o Bear Stearns, and the Bank

o America-Merrill Lynch merger. Since 2008, banks also have been unding

themselves with more deposits and less debt.

Among US households, debt has allen by 4 percent in absolute terms, or

$584 billion (Exhibit 6). Some two-thirds o that reduction is rom deaults on

home loans22 and other consumer debt. An estimated $254 billion o troubled

mortgages remain in the oreclosure pipeline,23 suggesting the potential or

several more percentage points o household debt reduction as these loans are

discharged.24 A majority o deaults refect nancial distress: overextended

22 The mortgage charge-o data are unocial estimates provided by Jim Kennedy at the Federal

Reserve Board.

23 This estimate is based on shadow inventory data rom CoreLogic, which includes seriouslydelinquent loans, those in the oreclosure pipeline, and those already seized by lenders. We

subtract seized loans rom CoreLogics shadow inventory to count only loans that will aect

outstanding levels o household debt.

24 This calculation ignores uture growth in disposable income in order to isolate the impact o

eliminating the shadow loan inventory.

Eiit 5

The United States has undergone rapid

private-sector deleveraging since 2008

986961

4843

61

45

60

3737

0

50

100

150

200

250

300

350

64

23

208

Q4-

1980

51

16

Q1

1975

148

53

15

220

65

41

Q4-

1990

79

57

Q4

2000

Q2

2011

279

87

72

40

80

Q4

2008

296

152

14

29

16

16

75

-7

-11

-17

19

-16

SOURCE: US Federal Reserve Flow of Funds; McKinsey Global Institute

1 Includes all loans and credit market borrowing (e.g., bonds, commercial paper); excludes asset-backed securities to avoid

double counting of the underlying loan.


Debt1 by sector, 19752011

% of GDP

Government



Households

Change

Percentage points

Q4 2000

Q4 2008

Q4 2008

Q2 2011


27/64


homeowners who lost jobs or aced medical emergencies and ound that they

could not aord to keep up with payments. Low-income households are aected

most by deaultsin areas with high oreclosure rates, the average annual

household income is around $35,000, compared with $55,000 in areas with low

oreclosure rates.25

Up to 35 percent o US mor tgage deaults, it is estimated, are the result o

strategic decisions by borrowers to walk away rom homes that have negative

equity, or those in which the mortgage exceeds the value o the property. This

option is more available in the United States than in other countries, because

in 11 o the 50 statesincluding hard-hit Arizona and Caliorniamortgages

are nonrecourse loans. This means that lenders cannot pursue other assets or

income o borrowers who deault. Even in recourse states, US banks historically

have rarely pursued nonhousing assets o borrowers who deault.26

We estimate that US households could ace roughly two more years o

deleveraging. As noted above, there is no accepted denition o the sae level o

household debt, which might serve as a target or deleveraging. One possible

goal is or the ratio o household debt relative to disposable income to return

to its historic trend. Between 1952 and 2000, this ratio rose steadilyby about

1.5 percent annuallyrefecting growing access to mor tgages, consumer

credit, student loans, and other orms o credit in the United States. Ater 2000,

growth in household borrowing accelerated, and by 2008, growth in the ratio

o household debt to income had climbed more than 30 percentage points

above the trend line. By the second quarter o 2011, this ratio had allen by

25 The state o the nations housing 2011, Joint Center or Housing Studies o Harvard

University, June 2011.

26 Recently, lenders have been more willing to pursue nonhousing assets, where permitted. See

Jessica Silver-Greenberg, House is gone but debt lives on, The Wall Street Journal, October

1, 2011.

Eiit 6

126

153

13,258

-584

Q2 2011Othercredit1

Consumercredit

153

42

Homemortgages(includinghome equityloans)

363

Q4 2008

13,842

-4%

US household debt has fallen in absolute terms;

two-thirds has been due to defaults

Household debt, Q4 2008Q2 2011

$ billion

SOURCE: US Federal Reserve; McKinsey Global Institute

1 Other credit comprises commercial mortgages, other bank loans, other loans and advances, and municipal securities.NOTE: Numbers may not sum due to rounding.

Home mortgages

Consumer credit

Home equity loans

Other credit1

Q2 2011

13,258

9,053

2,402

924

879

Default

Repayment


28/64

20

15 percentage points. At the current rate o deleveraging, it could return to trend

by mid-2013 (Exhibit 7).

In the wake o a highly destructive nancia l crisis, it is reasonable to ask whether

a continuous upward trend in household borrowing is sustainable. A more

conservative goal or US household deleveraging, then, might be to aim or a

return to the ratio o debt relative to income o 2000, beore the credit bubble.27

This would require a reduction o 22 percentage points rom the ratio o mid-2011.

Another comparison is with Swedish households in the 1990s, which reduced

household debt relative to income by 41 percentage points. By this measure,

US households are a bit more than one-third o the way through deleveraging

(Exhibit 8).

Another way to gauge progress in household deleveraging is to look at the

household debt service ratio. This ratio in the United States has declined rom

14 percent o disposable income at the peak in 2007 to 11.5 percentwell below

where it stood in 2000. Some o the progress on this metric refects very low

prevailing interest rates, but it is nevertheless a sign that US households are

moving in the right direction. It should also be noted, however, that the rate o

deleveraging and the strength o recovery vary considerably across the country

(see Box 1, Multispeed recovery in the United States).

27 We use 2000 or the pre-crisis baseline comparisons throughout.

Eiit 7

SOURCE: US Federal Reserve; CoreLogic; Haver Analytics; McKinsey Global Institute

40

50

60

70

80

90

100

110

120

130

-15 p.p.

Q2

2013

05200095908580757065601955

Projected1

Trend line based

on 19552000 data

HistoricalThe US household debt ratio could return toits long-term trend in 2013

1 This is based on estimates of the foreclosure pipeline in Q2 2011 and ignores future growth in disposable income.

Household debt

% of disposable personal income, seasonally adjusted


29/64


Even ater US consumers nish deleveraging, they probably wont be as powerul

an engine o global growth as they were beore the crisis. Thats because they

no longer have easy access to home equity loans and cash-out renancing.

From 2003 to 2007, US consumers extracted $2.2 trillion o equity rom their

homes, but since then home prices have allen and lending standards havetightened. We calculate that without the extra consumption that home equity

extraction enabled,28 growth in real consumption would have averaged around

2 percent annually, a percentage point lower than the actual growth rate or that

period. In the third quarter o 2011, US consumer spending grew 2 percent on an

annualized basis, which may be c lose to the steady state that can be expected in

coming years.

Government debt has risen rapidly in the United States since the crisis, due

to the sharp decline in tax revenue and increases in automatic spending or

items such as unemployment benets.29 Because the United States entered the

nancial crisis with growing decits, government debtincluding that o ederal,

state, and local governmentshas reached its highest level as a percent o GDP

since World War II. The next phase o the de leveraging process, in which the

government begins the arduous process o reducing decits and then debt itsel,

requires dicult political choices that policy makers have thus ar been unable to

make.

28 An estimated 20 percent o the money rom home equity loans and cash-out renancings wasspent on consumption.

29 Falling tax receipts due to lower output account or an estimated 40 percent o the incease in

public debt in G-7 economies since the crisis; scal stimulus and assistance to the nancial

sector account or 30 percent. See Car lo Cottarelli and Andrea Schaechter, Long-term trends

in public nances in the G-7 economies, IMF Sta Position Note 10/13, September 2010.

Eiit 8

SOURCE: Haver Analytics; Statistics Sweden; McKinsey Global Institute

Credit boom Deleveraging

NOTE: 2011 figures are as of Q2 2011.

Spain

(Year 0 = 2007)

United States

(Year 0 = 2008)

United Kingdom

(Year 0 = 2008)

Sweden

(Year 0 = 1988)

Household debt

% of disposable income

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9

90

80

160

150

140

130

120

110

100-41 p.p.

-10 p.p.

-6 p.p.-15 p.p.

70

0

US households are about one-third of the way to

the Swedish level of debt reduction

Peakhousehold

debt

Years


30/64

22

b 1. Mtiee ee i te uite stte

During the credit boom, levels o debt accumulation and housing price

increases varied widely across the United States. Now there are signicant

dierences in the rate o economic recovery across regions, too. For

business leaders operating in the United States, understanding these

regional dierences will be important.

Not surprisingly, states where the real estate bubble was largest are

struggling with the economic a termath. As o Q3 2011, in Nevada,

58 percent o mortgages exceed current home values; in Florida, the gure

is 44 percent. These states also have among the highest ratios o household

debt to income (Exhibit 9). This not only results in higher oreclosure rates

but also contributes to above-average unemployment. Moodys Analytics

predicts that real output will not return to its pre-crisis level beore 2014 in

Nevada and 2013 in Florida.1

By contrast, in Texas, real output was back to its pre-crisis level by 2009,

unemployment is below the national average, and household debt is

low. In New York, real output returned to the pre-crisis level in 2010, and

unemployment is around 8 percent. In both states, the share o homes with

negative equity is well below the 22 percent national average (10 percent in

Texas, 6 percent in New York).

The perormance o cities varies as well. Real output has recovered to pre-

crisis levels in 65 o the largest metropolitan statistical areas, but other cities

are unlikely to regain pre-crisis output beore 2014.

1 Based on regional output data rom Moodys Analytics, December 2011.

Eiit 9

Household debt levels vary significantly across US states

Debt, 2000% of disposable

income

79

93100

107

120

153

176186

78

919098

108

130

157160

Nevada TexasNew YorkMichiganIllinoisFloridaArizonaCalifornia

2010

2008

SOURCE: Federal Reserve; Bureau of Economic Analysis; McKinsey Global Institute

Household debt1

% of disposable income, annual average

1 Household debt balances by state are estimated by the Federal Reserve of New York based on the population with a credit

report. We estimate household debt to disposable income by state using additional data from the BEA. The average acrossstates based on this data does not match US Flow of Funds data used elsewhere in this report.

101 90 68 6272 617183


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24

UK households have reduced debt loads only slightly so ar, with the ratio o

debt to disposable income declining rom 156 percent in 2008 to 146 percent in

mid-2011. This level is still signicantly higher than that o US households at the

bubbles peak. UK household debt has grown slightly, in absolute terms, since

2008. Residential mor tgage lending has continued to expand, albeit slowly, andthis new debt has been only partiall y oset by a 25 billion decline in consumer

credit. We nd that at the recent rate o deleveraging, the ratio o UK household

debt to disposable income would not return to its pre-bubble trend or another

decade.31

Slower household deleveraging in the United Kingdom can be attributed in par t

to the relatively small number o troubled mortgages that have progressed to

oreclosure. That picture could change: the Bank o England estimates that up to

12 percent o all UK mortgages are in some state o orbearance; an additional

2 percent are delinquent.32 This implies that the United Kingdom may have about

the same proportion o loans that are in some degree o diculty as the United

States has14 percent o mortgages outstanding (Exhibit 12). The problem could

deepen in the years to come, particularly i economic growth remains weak or

interest rates rise sharply. Two-thirds o UK mor tgages have foating interest rates,

and monthly debt payments o UK households as a share o income are already

one-third higher than those in the United States. On top o this, 23 percent o UK

households report that they are somewhat or heavily burdened in paying o

unsecured debt.33

31 The Oce or Budget Responsibility predicts even slower rates o household deleveraging andanticipates no reduction in the household debt-to-disposable income ratio through 2016. See

Oce or Budget Responsibi lity, Economic and scal outlook, November 2011.

32 The true extent o troubled mortgages in the United Kingdom is not known, as banks are not

required to report publicly or to regulators the number o mor tgages in orbearance.

33 2010 NMG Consulting survey o UK households.

Eiit 11

Net direct exposure1 to debt of Greece, Italy, Ireland, Portugal, and Spain

Banks participating in ECB stress test$ billion

UK banks are highly exposed to the private debt of

eurozone-crisis economies

1436

38

74

35

120

65

186

11519

4252

105

173

294

507

Italy2Nether-

lands

DenmarkCyprusBelgiumSpain2GermanyUnited

Kingdom

France

Private sectorSovereign

SOURCE: European Banking Authority; McKinsey Global Institute

1 Net direct exposure defined as gross cash long minus gross cash short.2 Excludes exposure to domestic debt.


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The United Kingdom diverges rom the Swedish path not only in its slow rate

o household debt reduction relative to GDP, but also in its decision to make

reducing public debt a high priority early in the deleveraging process. However,

like the United States, the United Kingdom entered the nancial crisis with a

decit and growing government debt. By contrast, Sweden entered its crisiswith a government scal surplus and Finland entered with low government debt.

Moreover, the Nordic countries did not operate in an environment o he ightened

concern about sovereign risk. Today, the UK government appears to have

little i any scal headroomalthough this remains a matter o debate among

economists.34 How the current UK approach aects the economys ability to

move on to the second, growth-led phase o deleveraging remains to be seen.

Another question hanging over the UK recovery is how evenly growth is spread.

The London region generated hal o GDP growth in the decade leading up to the

crisis and continues to grow more quickly than the rest o the nation. To contain

and then reduce government debt over many years, the United Kingdom will need

more broad-based growth.

Examining the net saving position o di erent sectors o the UK economy helps

explain the need to restore UK private-sector investment and contain government

debt. Exhibit 13 shows the sharp rise in net saving by the UK private sector in

the atermath o the crisis. Households switched rom being large borrowers to

becoming net lenders to the rest o the economy and, in the process, reduced

consumption. At the same time, public-sector borrowing has grown rapidly

because o alling tax revenue, rising automatic payments, and the bailout o

troubled banks. I the government is to meet its goal o e liminating the structural

decit, either the current account balance must improve dramatically (to levels

34 The UKs Oce or Budget Responsibilit y orecasts net government debt to peak at

78 percent o GDP in scal year 2014/15, and gross debt to peak at a little over 90 percent

o GDP. Swedens gross debt peaked at 83 percent o GDP. For a discussion o addi tional

capacity or government borrowing, see Jonathan D. Ostry, Atish R. Ghosh, Jun I. Kim, and

Mahvash S. Qureshi, Fiscal Space, IMF Sta Position Note, SPN/10/11, September 1, 2010.

Eiit 12

Number of residential mortgages in difficulty

% of total residential mortgage loans

The share of UK mortgage holders in some difficulty is similar to

that in the United States

United States1

United Kingdom2 14.22.2 12.0

14.24.5 8.3 1.4

In forbearance

In foreclosure

Delinquent

1 US data as of Q1 2011. Forbearance is estimated for August 2011 based on loan modifications under the US Home

Affordable Modification Program (HAMP). Delinquency data represent mortgages more than 30 days delinquent.

2 UK delinquency data are as of Q2 2011 and represent mortgage loans more than 1.5 percent in arrears. Estimates for

forbearance are worst-case estimates from the Bank of England Financial Stability Report, June 2011.

SOURCE: Mortgage Bankers Association; Bank of England; McKinsey Global Institute


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26

not seen in the past decade) or the private sector must spend more. This could

be achieved through higher investment by private rms, since nonnancial

businesses have the largest saving surplus o any UK sector. Or consumers could

start borrowing even more as the government reduces its decitsbut that would

be risky, given the continuing high levels o consumer debt.

si: Te g e

Spain aces a particularly dicult challenge in reducing debt, since it is

constrained in its ability to use scal or monetary policy to revive growth.

Ater Spain adopted the euro in 1999, its interest rates ell by approximately

40 percent as lending rates moved closer to the European average. As a result,

lending soared and Spains already rapid growth accelerated. Nominal GDP

grew 8 percent annually rom 2000 to 2007. A housing and construction boom

produced ve mill ion new residential units between 1997 and 2007a roughly

25 percent increase in supply. Over the same period the number o Spanish

households increased by 2.5 million, rom 13 million to 15.5 million.35 Householdand corporate debt grew signicantly rom 2000 to 2008, reaching 85 percent o

GDP or households and 137 percent o GDP or nonnancial corporations.

Spains private-sector debt has allen only slightly since the nancial crisis began

and Spains total debt has continued to c limb (Exhibit 14). Although Spains

government debt stood at a modest 47 percent o GDP in 2008, refecting eight

years o a decline in the ratio o government debt to GDP, it has increased by

24 percentage points since then. Spains ratio o household debt to disposable

income has allen by 6 percentage points; in absolute terms, outstanding

household debt has declined by 3 percent. As in the United Kingdom, home

mortgages have continued to grow while consumer credit has allen sharply.

35 Spanish net immigration was substantial over the same periodaround 4 million net migrants

in total rom 2002 to 2007.

Eiit 13

UK public borrowing has increased dramatically since the crisis;

households have become net lenders to the economy

1 Includes nonprofit institutions serving households.

SOURCE: UK Office for National Statistics; McKinsey Global Institute

-12

-10

-8

-6

-4

-2

0

2

4

6

Rest of world

Government

Households1



Q2

2011

Q4

2008

Q4

2006

Q4

2004

Q4

2002

Q4

2000

Net borrowing and lending, Q4 2000Q2 2011

% of GDP, four-quarter moving average


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Spains ocial mor tgage deault rate remains relatively low, but more trouble may

lie ahead or Spanish households. Spains unemployment rate is 21.5 percent, up

rom 9 percent in 2006. For now, households continue to make payments to avoid

the countrys stringent recourse laws, which allow lenders to go ater bor rowers

assets and income or a long period.

Spain, unlike most other developed economies, also aces a very signicant

deleveraging challenge in its corporate sector. The debt o nonnancial

corporations nearly doubled relative to GDP during the boom, rom 74 percent o

GDP in 2000 to 137 percent in 2008. It has dropped only slightly to 134 percent

o GDP since then. High corporate debt ratios are partly due to the growth o

Spains real estate and construction sectors, but leverage is a lso high across such

industries as manuacturing, energy, utilities, and tourism and hospitality. In real

estate and construction, the ratio o debt to gross operating prot is more than

50 percent higher in Spain than in a weighted average o eurozone economies. In

the tourism and hospitality sector, this ratio is more than twice as high in Spain

as in other European countries. Spanish corporations hold 20 percent more debt

relative to national output than French and UK companies, twice as much as

US companies, and three times as much as rms in Germany (Exhibit 15). Debt

reduction in Spains corporate sector may weigh on growth in the years to come.

Eiit 14

Spains private debt grew rapidly after 2000;

public debt has grown faster since 2008

85

4530

47

63

40

0

100

200

300

400

Q2

2011

363

82

134

76

71

Q4

2008

337

137

68

Q4

2000

192

74

10

Q4

1990

131

1249

64

40

58

-16

145

-4

-3

8

24

26

SOURCE: Haver Analytics; McKinsey Global Institute

1 Includes all loans and credit market borrowing (e.g., bonds, commercial paper); excludes asset-backed securities to avoid

double counting of the underlying loan.


Debt1 by sector, 19902011

% of GDP Households



Government

Change

Percentage points

Q4 2000

Q4 2008

Q4 2008

Q2 2011


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28

The prospects or Spains banking sector remain uncer tain. The countrys smaller

regional banks, the cajas, are heavily exposed to local real estate markets,

and housing price declines have let many loans in trouble. O the eight banks

that ailed the European Banking Authoritys stress tests in 2011, ve were

Spanish and ailed largely due to their exposure to real estate. The Bank oSpain estimates that banks hold 340 bi llion in loans connected to real estate

development, and as many as hal o these loans may be in trouble.36 Spains new

center-right government, elected in November 2011, has announced new austerity

measures and has signaled its intention to address lingering issues in the nancial

sector, including recognizing losses related to the rea l estate bubble.

Spains deleveraging challenge is complicated by its restricted range o policy

options. Private investors have grown nervous about Spains growth prospects,

and

McKinsey - Del Ever Aging Jan 2012

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