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Private debt shrinks, offsetting expanding government debt

by Katharine Lau
March 11, 2010

Private debt continued to contract in the fourth quarter of 2009, while U.S. government debt continued to expand, according to a report released by the Federal Reserve Thursday. It’s a sign although households and businesses are paying back their debts and getting their finances in order, the government still continues to prop up the economy with deficit spending.

“It means we are reducing our household debt which is good in the long term,” said Adolfo Laurenti, deputy chief economist at Mesirow Financial Holdings Inc. “It’s a mixed blessing in the short term for businesses because they’re paying back debt, and in the long term, it means they’ll be in better shape to spend later.”

Debt in the domestic nonfinancial sector grew at a seasonally adjusted annual rate of an estimated 1.6 percent to $34.7 trillion in the fourth quarter, according to the Federal Reserve’s flow of funds report. The rate was about 1.3 percentage points lower than the same period a year earlier. For all of 2009, domestic nonfinancial debt totaled $34.7 trillion.

Meanwhile, household debt declined at an annual rate of 1.2 percent to $13.5 trillion and consumer credit contracted at an annual rate of 5.8 percent. Nonfinancial business debt decreased at an annual rate of 3.2 percent to $11 trillion. For all of 2009, household debt totaled $13.5 trillion, while nonfinancial business debt stood at $11 trillion.

Federal government debt, on the other hand, rose at an annual rate of 12.6 percent in the fourth quarter, about half the rate of the past two years, according to the report. For all of 2009, federal government debt increased almost 23 percent to $10.2 trillion.

“The government is still spending a lot of money,” Laurenti said. “It’s always a trade-off. People are happy the government is spending in the short term, but it’s not good for the long term.”

Such spending will eventually force the U.S. Treasury to sell more bonds at a higher interest rate or the government will have to raise taxes, Laurenti said.

Republicans in Washington have been voicing concern about government spending and the need to balance the budget, which President Obama addressed in his Jan. 27 State of the Union Address. Still, a good chunk of the stimulus funds from the American Recovery and Reinvestment Act have yet to be disbursed.

“Through 2010, money will still be spent,” Laurenti said. “If healthcare should pass, the numbers will turn for the worse. I don’t really see any signs of fiscal discipline coming from Washington yet.”

There were some encouraging signs in the report. Household net worth totaled $54.2 trillion at the end of the fourth quarter, up 1.3 percent from the third quarter. Household net worth is defined as liabilities, such as mortgage debt, subtracted from assets, such as home equity. For all of 2009, household net worth rose $2.8 trillion.