Data from the Federal Reserve’s Flow of Funds report shows that non-financial, non-farm, proprietorships and partnerships have deleveraged considerably since 2009. From 2009 to 2013, liabilities as a share of proprietors’ equity of these businesses declined from 92.4 percent to 68.8 percent.
While that reduction is substantial, the ratio of borrowing to net worth will need to fall further to return to historical levels.
In the 1980s, liabilities at the average non-financial, non-corporate business were relatively modest. But borrowing at these businesses grew significantly in the second half of the 1990s and first half of the 2000s. Measured in inflation-adjusted terms, the amount of liabilities at the average non-corporate non-financial business increased from $121,000 in 1994 to $227,000 in 2008 (measured in 2010 dollars). By 2011, average liabilities had declined slightly to $209,000 (measured in 2010 dollars). But, when adjusted for inflation, non-farm sole proprietorships and partnerships had more outstanding liabilities in 2011 than they did in any year between 1980 and 2006.
Of course, if a business’s net worth increases, its debt can also rise without becoming out of line. In fact, for most of the 1980s, 1990s and early-2000s, the upward trend in liabilities at non-financial, non-corporate, non-farm businesses was only slightly greater than the positive trend in proprietors’ equity.
However, in the years just prior to the financial crisis, the ratio of the liabilities to equity of non-farm non-financial sole proprietorships and partnerships soared, increasing from 49.7 in 2005 to 92.4 percent in 2009. Then from 2009 to 2013, non-financial, non-corporate, non-farm businesses experienced substantial deleveraging, with the ratio of liabilities to proprietors’ equity falling by over 25 percent.
The Federal Reserve data suggest that this pattern of leveraging and deleveraging was driven by a plunge in proprietors’ equity during the Great Recession, as the figure above indicates. The economic downturn put an end to rising liabilities (though it did not lead them to fall). At the same time, the poor economic conditions led to a plunge in proprietors’ equity between 2007 and 2009. Owners’ net worth then rebounded in the post-2009 economic recovery, resulting in the pattern of a rising and then declining ratio of liabilities to proprietor’s equity.
Image: Created from data from the Federal Reserve’s Flow of Funds report