Is a Household Debt Overhang Holding Back Consumption?

The recent plunge in U.S. home prices left many households
that had borrowed voraciously during the credit boom highly leveraged, with
very high levels of debt relative to the value of their assets. Analysts often
assert that this “debt overhang” created a need for household deleveraging that,
in turn, has been depressing consumer spending and impeding the economic
recovery. This paper uses household-level data to examine this hypothesis. I
find that highly leveraged homeowners had larger declines in spending between
2007 and 2009 than other homeowners, despite having smaller changes in
net worth, suggesting that their leverage weighed on consumption above and
beyond what would have been predicted by wealth effects alone. Results from
regressions that control for wealth effects and other factors support the view
that excessive leverage has contributed to the weakness in consumption. I
also show that U.S. households, on the whole, have made limited progress in
reducing leverage over the past few years. It may take many years for some
households to reduce their leverage to precrisis norms. Thus, the effects of
deleveraging may persist for some time to come.