Households - Another Quarter Older and Deeper In Debt

By: Paul Kasriel | Tue, Dec 13, 2005
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Here's the good news. In the third quarter, the market value of households' assets increased by 2.7%. Here's the bad news, the value of households' liabilities increased by 3.0%. So, the leverage of households moved up to 18.24% in the third quarter from 18.19% in the second quarter (see Chart 1). The third quarter household leverage ratio is the highest since the record high of 18.32% set in the first quarter of 2003.

Chart 1

A lot of the increased household indebtedness resulted from home"owners?" tapping the equity in their houses. At an annual rate, households withdrew from their personal "home ATMs" a net $452.3 billion (see Chart 2). This, of course, was the principal reason households were able to consume and pay principal and interest on non- mortgage debt by an annualized record amount of a $132.9 billion in excess of what they earned after taxes.

Chart 2

Speaking of paying principal and interest on debt, households devoted a record 13.75% of their after-tax income to servicing their total debt, including mortgage debt (see Chart 3). With some analysts estimating that $2-1/2 trillion of household debt will be repriced upward next year because of the increase in interest rates, the household debt-service ratio is bound to climb to new highs.

Chart 3

Here's some more good news. As shown in Chart 4, household net worth in relation to after-tax income continues to rebound, reaching 565% -- almost back to its percentage at the end of 2000.

Chart 4

There are two ways that households can increase their net worth: (1) spend less than they earn after taxes or (2) be fortunate to own an asset that is rising in value. Well, we know number one has not been the way households have been increasing their net worth of late. As Chart 5 shows, in the past three years, holding gains on previously-purchased assets has been the main driver of increases in household net worth. And, in the second and third quarters of this year, holding gains on assets accounted for more than 100% of increases in household net worth. And, as implied by Chart 6, holding gains on residential real estate has played a large role in accounting for the gains in household net worth. To be specific, since 2003:Q1, holding gains on residential real estate on average has accounted for 70% of the gains in household net worth. The median increase in real estate holding gains relative to increases in net worth has been 42%.

Chart 5

Chart 6

Now comes the bad news. This same runup in the market value of residential real estate that has fueled a large part of the increase in households' net worth has also been responsible for the decline in housing affordability to its lowest level since 1991. That is, the market value of residential real estate has risen to a record level relative to after-tax household income. Or, as shown in Chart 7, disposable personal income has fallen to a record low level relative to the market value of residential real estate, which has caused housing affordability to plunge.

Chart 7

With housing affordability plunging, holding gains on residential real estate are likely to moderate. Unless there is one heck of a rise in corporate equity prices to compensate for the milder increases in home prices, households might actually start to live within their income means again if they want to keep increasing their net worth. This is why I am bearish on consumer discretionary spending in the coming years.


Paul Kasriel

Author: Paul Kasriel

Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

Paul Kasriel

Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.

Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.

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