Are consumers cutting debt, shifting debt from one loan to another, or just sitting out of the debt market for a breather? There are three pieces to consumer debt: mortgage debt, credit card debt and installment debt (auto loans and student loans). Taking a close look at each one, there’s only one conclusion to draw from the data: Consumers are reducing their debts, and this will likely go on for years to come.

Mortgage Debt

Mortgage debt is the largest piece of consumer debt. Out of approximately $13 trillion in total consumer credit, mortgage debt represents $10.6 trillion, or 81.5%. That number has fallen by 5% since the beginning of 2008, when it totaled $11.2 trillion. This is a small decline relative to the significant drop in home values during that period — total mortgage debt has remained relatively flat while houses have lost a third of their value.

Next we show the aggregate equity position and loan-to-value ratios for homes with outstanding mortgages. For a frame of reference, let’s think about how long it will take for LTV ratios to come back simply to where they were five years ago. This seems like a reasonable yardstick, as this was a period of profligate consumer spending – where the market is hoping we’ll return. Currently the aggregate LTV of all mortgage holders is 88.4%. We are bearish on the outlook for home prices, and, as such, we assume there is unlikely to be any material appreciation, even in nominal terms, for a long time.

The following example helps explain the significance of this. Imagine that the US encumbered housing market is an analog to one household with one big mortgage. Assume that their home wasn’t going to rise in value for many years. Assume that they have a 30-year mortgage that they’re 3-4 years into at a 5.5% rate. The home is worth $175,000 and they have a $154,700 mortgage (88.4% LTV). Assume they aren’t interested in taking on more debt until that LTV gets back to where it was in 2004-2005, namely in the 60-62% range. Calculating the amortization, you’ll find that it will be 14-16 years before this household pays down its mortgage to levels consistent with a 60-62% LTV. We’re aware that this analysis relies on several key assumptions. The point, however, is that even with modest inflation in home prices it will be many years before these LTVs get back to levels consistent with even those observed in the middle part of this past decade.

Ultimately, we expect 10-15 years could pass before LTVs get back down to a level where re-leveraging can begin. This conclusion is profoundly different than most other predictions about when leverage will resume.

Credit Card Debt

Credit card debt is an important piece of the puzzle, but at $822 billion it now only represents 6.4% of the total, down from 7.6% in 2004. This debt, in aggregate, has fallen 15.5% since Lehman’s bankruptcy, a cumulative decline of $151 billion dollars.

The growth rate of total credit card debt has been on the decline since early 2008. While there was a clear inflection point in February 2010, when credit card debt began show slow growth again, we would caution strongly against getting overly excited here. Extrapolating the trajectory over the last six months, it will take two years for credit card debt to stop shrinking, and we doubt that growth thereafter will exceed GDP growth. Our firm expects that in light of the United States’ high and rising debt to GDP, GDP growth will remain in the low 1% range for many years to come. Now some might point out the positive marginal benefits of a less bad year-over-year reduction in revolving consumer credit, and there’s truth in that. However, it’s a long way from assuming that balances stabilize to assuming that growth returns to pre-Lehman rates.

This chart shows the magnitude of the 15.5% reduction of credit card debt over a longer time period – going back to 1968 – the inception of the series. We’ve never seen anything even remotely comparable to the paydown being seen today. This should tell you that there is a wholesale consumer mind-shift taking place with respect to their attitudes around credit.

Installment debt (auto loans, student loans along with miscellaneous, i.e. RV loans, etc)

Finally, installment debt is $1.6 trillion, or 12.2% of total consumer debt, with auto loans making up the vast majority of that (~80%). Installment debt has remained steady throughout this recession principally because of the auto piece. A car has become a mainstay of today’s economy. The vast majority of Americans need a car to work or to do anything, outside of a handful of densely-populated cities. As such, it is not surprising to see installment debt remain relatively stable during recessions. It’s also worth pointing out that an important driver here may be the fact that the much smaller piece of installment loans, namely student loans (~15%), is still growing so fast that it offsets a nominal rate of decline in auto loans leading the overall installment loan category to appear flat to down only slightly.

Overall Debt

This takes us to total household debt. We’ve combined household mortgage debt, credit card debt and consumer installment debt in the charts below to show the trend.

The first chart shows total household debt rose sharply from 2004 to mid-2008, increasing 31.6% in just three and a half years to a record $13.8 trillion dollars. Since then, every quarter has been marked by a reduction in household debt. In total, consumers have shaved some $701 billion or 5.1% during the last two years.

The second chart is arguably the most interesting chart in this report. It shows the year-over-year change (%) in total household debt looking back over the last seven quarters. The trend is unambiguous. Total household debt is declining, and it is declining at an accelerating rate. In the second quarter of 2010, total household debt fell at a rate of 3.4% year-over-year, the fastest rate of decline since the start of the recession.

We doubt that consumers will come back to the debt trough anytime soon. Consumers conceptualize their debt in totality, taking all the pieces in aggregate, and they evaluate their debt relative to their income and their wealth. The lost value in their housing wealth is profound for most families across America. This will, on the margin, keep them wary of taking on more debt for many years to come. For those who believe that old habits will swiftly return, we think the above analysis offers reasonable doubt. We wouldn’t bank on a return to profligate, debt-fueled consumer spending anytime soon.