Wealth effect update: Q1 2009

Saturday, June 13, 2009

The Federal Reserve released its aggregate flow of funds report for Q1 2009. I will post further insight as I get into the nuts and bolts of the report, but here is an update of the household balance sheet as of March 31, 2009.

Household net worth, total assets minus liabilities, is falling at a 16.25% annual clip. The 2.6% decline from Q4 2008 to Q1 2009 is driven by a precipitous drop in the value of tangible assets (mostly housing but also durable goods), -2.3%, and financial assets (credit instruments, deposits, corporate equities, mutual funds, pension reserves, etc.), -2.2%. Liabilities fell 0.8%, mostly on a 2.9% reduction in consumer credit (mortgages went essentially unchanged). The Q1 annual decline in net-worth is smaller than that seen in Q4 2008, -17.4%.

The measure of housing valuation uses the Federal Housing Finance Agency's home price index, which showed a slowing quarterly rate of decline in Q1 2009, -0.5%, compared to that in Q4 2008, -3.3%. The S&P Case Shiller home price index (which includes mortgages that are not guaranteed by Fannie Mae and Freddie Mac) fell a quarterly 7.5% in Q1 2009, down from 7.4% in Q4 2008. Point: the loss in net-worth may be somewhat understated.

Another way to look at the effects of wealth destruction on consumption patterns (the so-called wealth effect) is by the ratio of net worth to disposable income.
The chart illustrates wealth to disposable personal income from Q1 1951 to Q1 2009. Between 2005 and 2007, this ratio averaged a whopping 6.2. During the period 2005-2007, tangible asset values fell almost 1%, while financial assets grew a huge 16%! Liabilities likewise grew almost 18%, mostly on accumulated mortgage debt. Oh man.

At any rate, it is no wonder why households are reacting so vehemently to the liabilities side of the balance sheet right now: reducing consumption and increasing saving. Would a full recovery of asset markets repair household balance sheets enough to stabilize shifts in saving due to the wealth effect? Probably, but that may be a while. According to Reinhart and Rogoff, the average banking crisis real equity price cycle lasts an average 3.4 years (dropping 55%, a mark the S&P hit in February).

Rebecca Wilder


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