Northern Trust's Paul Kasriel wrote a terrific commentary last week. 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 the consumer, by 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.
To sum this up, in the past few quarters we have seen a sharp slowdown in household borrowing.
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 assets).
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 can go to Northern Trust's research site to read Kasriel's entire commentary entitled Festivus Flow-of-Funds Stocking Stuffers