The California Paradox: Highest Per Capita Debt, Lowest Default Rate

In the months immediately following the financial crisis, the press was filled with sad stories of countless California defaulters who had gotten burned by having too much debt (most of it invested in housing) and who promptly defaulted after the value of their primary asset, their house, plunged when the housing bubble burst. And then, these stories of financial failure gradually stopped. One reason for this is that overall per capital debt did decline… modestly. After hitting $90,000, it has since dropped to just shy of $70,000, even though it is once again rising.

Nonetheless, the average per capita debt in California remains the highest in the US by a margin of about $10,000 as the latest household credit report released today by the NY Fed showed.

Why does the average Californian carry so much debt? The answer is simple: housing. At over $50,000, or 75% of the total, the biggest component of the total debt pile is mortgage debt. Other states where residents are comparably crippled by mortgage debt include New Jersey, Arizona and so on.

This in itself is not surprising: after all old habits die hard, and with housing still exorbitantly expensive, US consumers have no choice but to take on substantial amounts of mortgage debt if they want to own a house.

What did surprise us, however, was the following chart which shows the relative defaults rates by state (percentage of debt balances that are 90+ days late). What is curious is that while California may have the highest per capita debt, it also has the lowest default rate across the entire US (red line in chart below). Which is incidentally where it also was in the years 2003-2005, just before its default rate exploded after the subprime bubble burst.

How is this happening? Also according to the NY Fed, which uses Equifax data, the reason why Californians may have the most debt and yet the lowest default rates is because the percentage of new foreclosures in California is the lowest of all states.

What is the take home message here? Is it that the more debt one has, the lower the probability of defaulting, so do it now?

Hardly. Just like California went from having the lowest default rate in the early 2000s to one of the highest ones just a few months after the housing bubble burst (surpassed only by the Nevada strippers owning 3 or more houses), so too what is happening now is simple: low interest rates allowing homeowners to refi into increasingly cheaper mortgages are merely delaying the day of reckoning, even as overall debt has once again started to rise, as has been the case for corporate America.

And while last time it was subprime that was the “enabling” feature that sprung open a default cycle, this time it will be increasing mortgage rates, something the Fed is desperately set on achieving even if it means unleashing helicopter money (since every attempt by the Fed to raise the short end leads to even more curve flattening). Furthermore, in recent years, the real consumer credit weakness has been focused not so much at the level of data aggregated by Equifax, and thys the NY Fed, but has concentrated among peer-2-peer lenders. For those following the Lending Club fiasco, we don’t have to tell you how that particular chapter in the US consumer credit scramble ends.

For now, however, let’s enjoy the drama of the California paradox, where in the latest farcical manifestation of the New Abnormal, the state with the most per capita debt is also the one with the lowest default rate.

Source: NY Fed