The State of the Consumer, by the Numbers

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
tangible assets.

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
Paul Kasriel
December 15, 2006

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What's been said:

Discussions found on the web:
  1. kim commented on Dec 21

    Please note: when i click on the “continue reading” hypertext, no additional information is loaded … perhaps this is just a firefox issue?

  2. todd commented on Dec 21

    nope, i’m on IE and get the same thing – maybe that’s all there is?

  3. MAS (San Diego) commented on Dec 21

    The “continue reading” link should only be on the home page template, not the detail page template. I think it surfaced on the recent redesign.

  4. Jim M commented on Dec 21

    Paul Kasriel is indeed a National Treasure. I just wish I could read more….

  5. Joelle commented on Dec 21

    Problem solved. :)

  6. Michael C. commented on Dec 27

    Great charts, BR. Thank you!

    I remember seeing a few of these charts last year when they were at their peaks.

    Now they have fallen, some substantially, and still neither many analysts nor the equity markets have changed their status quo.

    Makes you wonder.

  7. GerryL commented on Dec 27

    I just saw the NAR’s chief economist and marketeting rep David Lereah on CNBC. I figured he would be taking a victory lap after this mornings new home sales number. Interestingly, he was cautious. I am sure he already knows tomorrows existing home sales number. Does that mean the number will be bad? It also makes me wonder if he should be making public appearances in front of an important economic number.

  8. dave commented on Dec 27

    More data and very well done. But it simply doesn’t matter to ‘magic bid.’

    The more penetrating question is when does all this begin to matter? That will be bank.

  9. Cherry commented on Dec 27

    Why take victory over poor New Home Sales? Yup, that is right, they were poor. About 1.000. Don’t be swayed by silly CB “annualizations”. Those idiots take 6 months before they can get actual result. See 99-2000 for how “accurate” they were intially. By h1 2008, they will be about 750 as the recession is nearing its ending(hopefully lol).

    FWIW, December the housing market is tannnnnnnnnkkkkkkkkkkkkkiiiiiiiiinnnnnnnnnggggggggg again. Mercy, worst since the “summer death spiral”. Things are falling apart wildly. Looks like the “real” beginning of the actually bust after 2006’s “normalization”.

  10. Nuts commented on Dec 27


    “the sky is falling ” !!!

    how often will you troll over here and continuously make that ridiculous claim… .. every month you say it, and when it doesn’t happen you come back the next month … you have no credibility

    it’s pathetic already

  11. My1ambition commented on Dec 27

    Together with all those claiming that “The inverted-yield curve doesn’t matter anymore” even though it often predicts recessions by about 12-months. Cherry still has time :)

  12. Cherry commented on Dec 27

    The sky is falling little man, you deal and except nuts. What is is, punk.

    It doesn’t happen? You moron, of course it happens, the numbers have been trending down for months now in Real Estate. The whole sector has “normalized” off the mad 2002-05 market and is now moving to legit bust.

    Get a freaking clue dweeb, nuts, NEVER call me out again, or I will make you a veggie, got that weak man?

  13. dave commented on Dec 28

    just one data point, but from an area with a very hot housing market last year.

    I was at Dillard’s today picking up a new sweatshirt. I asked the cashier, Tariq, how business was doing since Christmas. He said, with a sour look on his face, everyone is returning, nobody buying.

  14. My1ambition commented on Dec 28

    Cherry, ok we’re with you on the meltdown, but there’s really too many questions that need answering and many will be only with time.

    How will the government, Fed, investors react once the panic sets in?
    How long will it last?
    How extreme? 1907, 1929, 2000?
    What will be the investing opportunities?
    How much will housing effect the economy?
    Will the US recession effect China? India?
    What other geopolitical events will trigger a rebound/shock to the already existing financial troubles?

    As Mark Twain says “…it rhymes”. So it won’t be the 30s or 70s all over again. It will be different. It will be 2007.

    My point is that in order to play this one right you need to simply keep listening to what the markets are telling us. They decide. All of our hopes, emotions and predictions as many millions we may have banked in them must be ready for an about face at any moment.

  15. Cherry — wacko commented on Dec 28


    are you ok there ?

    what drugs are you on ?

    you’re the biggest TROLL on this site

    it’s pathetic to see you mangle the English language and make your weak arguments … it’s embarrasing to see you rant and rave here …. I actually feel bad for you

  16. jj commented on Dec 28

    New Home Sales —- higher than expected for the 3rd straight month , but still near a 6-year low

    Existing Home Sales —- higher than expected for the 2nd straight month

    Inventory down slightly

    Case-Shiller housing futures -1.9% now , was -5.2% three months ago ….

    maybe these numbers are aberrations and will be revised , but they’re certainly food for thought—-

    MBA applications were down big this week and are at a 5-month low ,

    prices year over year are still down and suffered their worst decline in September ,

    foreclosures up 42% in October

    we have a ways to go before this ends

  17. rajesh commented on Dec 30

    Why didn’t the drop in 1965 trigger a recession? Or did it and it’s not marked? Just curious.

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