According to data released yesterday by the Federal Reserve, total U.S. household debt fell 1.7 percent during 2009. While this rate of decline might not sound like much, this marked the only time since data collection started back in 1945 that a calendar year decline actually occurred—and there have been quite a few nasty recessions over that time period. Some of the drop in debt reflected consumers paying down credit cards, but the largest contribution (~80%) came from households defaulting on mortgages and other financial obligations stemming from deep job losses and crashing home prices.
Although the deleveraging process does create a lot of short-term pain, it does have a silver lining. As consumers rehabilitate their balance sheets by shedding debt and building up savings, they will have enough cash flow to support healthy growth in spending activity. Households have remained cautious thus far, having been spooked by the recession, financial crisis, etc, but predicting pent-up demand is very difficult and its emergence could have a significant positive impact on the economic recovery.