By JUSTIN LAHART And MARK WHITEHOUSE
U.S. families—by defaulting on their loans and scrimping on expenses—shouldered a smaller debt burden in 2010 than at any point in the previous six years, putting them in position to start spending more.
Total U.S. household debt, including mortgages and credit cards, fell for the second straight year in 2010 to $13.4 trillion, the Federal Reserve reported Thursday. That came to 116% of disposable income, down from a peak debt burden of 130% in 2007, and the lowest level since the fourth quarter of 2004.
With the help of rising stock prices, the decrease in debts put average household net worth at $505,000 at the end of 2010, up 5.1% from 2009, though still well below a peak of $595,000 in the second quarter of 2007, before housing prices plunged.
But any solace from the improving debt numbers has been tempered by worries over rising commodity prices, Chinese trade and the threat to Middle East oil supplies.
The Dow Jones Industrial Average skidded 228.46, or 1.87%, to 11984.61 on Thursday, after new data on Chinese trade raised concerns that Beijing's export growth might be slowing and unrest broke out in eastern Saudi Arabia.
The shrinking debt burden, though, brings U.S. consumers, whose purchases make up about one-sixth of global demand, closer to the point where they can make a big contribution to the world-wide recovery.
"You've seen a steady improvement in household balance sheets" in the U.S., saidJoseph Carson, an economist at AllianceBernstein in New York. "That should set the stage for better consumer spending in the year ahead." He expects consumer spending to grow at an inflation-adjusted rate of 2.8% in 2011, up from 1.8% last year.
Defaults on mortgages and credit cards played a large role in bringing down household debt, underscoring the extent of the financial distress still afflicting U.S. families. Commercial banks wrote off $118 billion in mortgage, credit-card and other consumer debt in 2010, the Fed said. That's over half the total $208.8 billion drop in household debt, which also includes new mortgages and credit cards.
Morari Shah, a 59-year-old Miami entrepreneur and real-estate investor, is among those taking a radical approach to reducing debts.
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Since late 2008, he and his wife have slashed their total debt from nearly $1 million to zero by walking away from the mortgages on four rental properties and paying off two others, all of which lost about half their value in the housing bust. He's no longer taking up to $4,000 from his monthly income to pay mortgage interest that the rental income didn't cover.
Instead, he and his wife are fulfilling their goal of building a new $350,000, four-bedroom home in the Dallas suburb of Lewisville, where they plan to retire. "It's a big relief," said Mr. Shah. "We went through some rough times, but now I'm comfortable and don't have to worry about my retirement."
Mr. Shah isn't alone. Jon Maddux, chief executive of YouWalkAway.com, a California-based company that advises people on how to default on mortgage debt, says he's getting between 200 and 250 new clients a month, up 8% from last year and about 50% from 2009.
"I thought we were going to be done with this in one or two years," said Mr. Maddux, who started the firm in 2008. "Now, we're three years into it, and it looks like it probably will peak this year or next." He said the average client sheds about $250,000 in mortgage debt.
People are also fixing their finances the hard way, by boosting the portion of their income that they use to pay down debt. The personal savings rate averaged 5.8% in 2010, up from a low of 1.4% in 2005, and back to a level last seen in the early 1990s.
Meanwhile, getting new loans is difficult as banks pull back on risk, and the private securitization markets that used to support mortgage lending remain largely closed.
But consumer debt, such as auto and student loans, has started growing again in recent months, suggesting that people might be getting in the mood to borrow again.
Even as U.S. households reduce their debt, the country's overall obligations are rising, with weak tax revenues and efforts to stimulate the economy translating into large budget deficits. Total U.S. nonfinancial debt rose 4.8% to $36.3 trillion, driven largely by a 20% increase in federal debt. Debts of nonfarm, nonfinancial companies rose 5.4% as companies took advantage of low interest rates, but much of that money went to boost their cash coffers, which grew to $1.9 trillion.
Many consumers still have a long way to go to get their finances in order. Some economists believe a healthy household-debt-to-disposable-income ratio would be 100% or lower.
Tougher bankruptcy rules have made it difficult for some consumers to shed their debts, and a weak job market has left millions without much income to spend.
As of January, wage and salary income stood at $20,953 a person in the U.S., up 2.89% from a year earlier, but still 3.69% below its previous peak in March 2008, according to the Commerce Department.
Linda Sharp, a 56-year-old electronic engineer, filed for bankruptcy in October 2009 after losing a high-paying, global sales job for a big maker of computer peripherals.
She managed to cut the combined monthly debt payments on her home, automobile and other loans to $3,750 a month from about $6,500 a month, but her total debt load of more than $500,000 hasn't changed.
She recently found a new sales job paying less than one-fifth what she used to make, and is getting some support from a friend to cover monthly expenses.
"I don't know if I am going to recover,"' said Ms. Sharp, who has a son in high school and a daughter in college. "I've spent my retirement savings on living while I was looking for a job."
Write to Justin Lahart at justin.lahart@wsj.com and Mark Whitehouse atmark.whitehouse@wsj.com
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