Given our focus today on Retail sales this week, it is appropriate to reference another source of data on the consumer.
This commentary comes to us via Northern Trust’s Paul Kasriel. Paul is the Senior Vice President and Director of Economic
Research at NT, and I had the pleasure of meeting him (and Caroline Baum) at Bloomberg last month. He is the recipient of the 2006 Lawrence R. Klein Award for Blue
Chip Forecasting Accuracy.
His recent commentary focused on the Fed’s Flow-of-Funds data. It is rather insightful work into consumer debt and savings. Some of it might be a bit beyond the interest of many readers, so to make it more accessible, I did a little slicing and dicing. Here is my highly edited version, emphasizing The State of Consumer, by the Numbers:
Kasriel: I love the Fed’s quarterly flow-of-funds report. It usually is the mother lode
of enlightening economic nuggets of information. And the Fed’s latest release on
December 7 of third-quarter data was rich with these nuggets.
The slowdown in
borrowing was due principally to the household sector: Chart 2 shows that after
hitting a post-WWII high of 14.6% in Q3:2005, household borrowing relative to
disposable personal income (DPI) dropped to 8.8% in Q3:2006 – the lowest since
7.6% in Q3:2001, when the economy was in a recession.
Notice in Chart 2 that
precipitous declines in this percentage tend to be followed by the onset of
economic recessions (indicated by the shaded areas in the chart).
Just to demonstrate how precipitous the current fall off in household borrowing
has been, I had Haver Analytics calculate the year-over-year change in household
borrowing relative to DPI. This is shown in Chart 3. Wow! The percentage is down
from year-ago by 5.8 points – the largest decline since Q2:1980, when President
Carter urged us to don sweaters and tear up our credit cards.
But in the current situation, households have not been cutting up their credit
cards but rather sharply scaling back the growth in their mortgage credit as the
housing market recedes. This is shown in Chart 4. The most recent year-over-year
decline in household mortgage borrowing as a percent of DPI is unprecedented in
the post-WWII period.
In sum, in the past few quarters, we have seen a sharp slowdown in household
Despite the fact that household mortgage borrowing has slowed in recent
quarters, the leverage in owner-occupied residential real estate reached a
record high 46.4% in Q3:2006, as shown in Chart 8. If mortgage borrowing slowed,
why the increase in leverage? Because, as shown in Chart 9, there has been a
sharp slowdown in the growth of the total market value of residential real
estate. With a still -sizeable excess inventory of homes for sale, continued
weak growth, perhaps even a contraction, in the market value of residential real
estate could reasonably be expected in 2007.
With the sharp slowdown in the growth of housing values, it is quite natural
that there also would be a sharp slowdown in the growth of homeowners’ equity.
This, combined with higher adjustable rate mortgage financing rates, has
resulted in a sharp slowing in mortgage equity withdrawal (MEW).
As shown in
Chart 10, MEW peaked at an annual rate of about $730 billion, or 8.1% of DPI in
Q3:2005, slowing to an annual rate of only $214 billion in Q3:2006. Along with
corporate stock retirement, MEW has been an important source of funding for
household deficit spending in recent years.
Therefore, this slowdown in MEW
would be expected to slow the growth in household spending, which, as shown in
Chart 11, has begun. On a year-over-year basis, growth in the sum of real
personal consumption and residential investment expenditures has slowed to 2.0%
in Q3:2006, the slowest growth since the past recession.
Household liquidity fell to a post-WWII low in Q3:2006 (see Chart 12). I am
using as a measure of liquidity household deposits and money market mutual funds
as a percent of total household liabilities.
Note these 3 factors:
1) Households already have borrowed
so much that their leverage ratio is at a post-WWII high (see Chart 13).
2) Households have already borrowed so much that their debt service
burden is at a 25-year record high (see Chart 14).
3) Residential real
estate, which accounts for 30.5% of the total market value of household assets
(see Chart 15), is the single largest asset in households’ portfolios compared
with deposits, credit market instruments, corporate equities (about 44% of which
are held on their behalf in pension funds and insurance companies) and other
Of these other asset categories, residential real estate
probably is the least liquid, aside from used refrigerators (other tangible
In sum, households have never been as highly levered as they are now or
as illiquid as they are now, and their single largest asset is in danger of
actually falling in value. If the Fed had to resume raising interest rates in
this environment, it would be "Katy, bar the door" for household finances!
(Some emphasis added).
I removed some of the more complex analysis of yield
curve inversion, overseas purchase of US Debt, and some more
challenging items. Those interested in reading the entire commentary
can go to Northern Trust’s research site (below).
Festivus Flow-of-Funds Stocking Stuffers
December 15, 2006