Damage Report 2008: Household Wealth Down $10 Trillion

by: Kirk Shinkle

Merrill Lynch has been among the more gloomy forecasters lately, and economist Sheryl King points to another reason why.

She writes that household balance sheets shed almost $3 trillion in the third quarter, thanks in large part to a decline in stock prices. That loss, the largest 3-month drop on record, brings the total loss by U.S. households in 2008 to $10 trillion, or about 10 years worth of equity earnings.

That is staggering.

Now for the bad news. From Merrill:

Real estate still tumbling

The Flow of Funds report also put a cap on the real estate boom, as those home ATMs pretty much fell silent. Household real estate assets fell for a 10th quarter out of the past 11 and the net worth of real estate is now down 32% since 2005. Mortgage debt actually declined in 3Q, by 1.7%, the first decline in 25 years. Moreover, we estimate that mortgage equity withdrawal was almost non-existent in 3Q, marking the lowest pace of home wealth extraction since the early 1990s – back in the day when no one had heard of option ARMs, interest only or NINJA mortgages.

Now the hard part

Persistent negative wealth effects from the slide in housing and equity prices should reinforce the uptrend in the personal savings rate, creating a highly disinflationary environment as job losses mount and unemployment rate rise toward 8-1/2% in the coming year. We estimate that the savings rate will rise to around 5% by 2010, on its way towards a more sustainable 6-7% at some point just beyond our forecast horizon. This is a daunting prospect for future US economic growth given that for every one percent increase in savings, consumer spending – that 70% of the GDP pie – is suppressed by a roughly equal amount.

Basically, to get growth back on track we need to spend more of the money we no longer have -- an unfortunate position containing little incentive to soothe just the sorts of fear-inducing paralysis that crippled markets this year and threaten to extend the duration of this recession.