What is a Balance Sheet Recession?

by David Gerlitz on September 7, 2011

Balance sheet recession is not a phrase uttered by the Mainstream media but is economist Richard Koo’s term for a baseline economic condition of private sector over-indebtedness. Koo termed this phrase based on his experiences during the still-ongoing Japanese malaise which began over 20 years ago, resulting in low government bond rates, minimal economic growth and fits of deflation.

What is balance sheet recession?The Japanese event was triggered by a Real Estate boom and resulted in corporate balance sheets being over-leveraged. As firms paid back debt (destroying money), it resulted in lower incomes and decreased economic activity.

US Balance Sheet Recession

This is the exact scenario we find ourselves in today in the US, although it is households which are experiencing the balance sheet recession, more so than firms. Our financial institutions, the largest of which were propped up by government support in 2008-2009 are also still experiencing a solvency crisis.

During the 1990’s and early 2000’s, households increased their debt as confidence in the tech bubble and portfolio wealth exploded. Unfortunately, President Clinton then exacerbated the private-debt explosion by running government surpluses in the late 90’s. This meant that, as the US Government ran an overall surplus while also running an account deficit (importing more than exporting), Private Sector savings necessarily had to turn negative. The tech bubble then popped, only to be propped up by the housing bubble of the early 2000’s. All of this exacerbated the private debt explosion, which necessarily reversed course in late 2008.

As a result, housing prices have plummeted, incomes have been reduced and households find themselves servicing a greater amount of debt on smaller income. This is a balance sheet recession, and only when private debt levels return to a sustainable level will significant economic growth resume.

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