Household Balance Sheet Repair Stumbles But Continues On

NAHB has been tracking two key economic variables that are critical for a robust and sustainable rebound in housing and the economy as a whole: the ratio of household net worth to disposable income (NW/DPI) and the personal savings rate.

The NW/DPI ratio can be thought of a measure of the health of household balance sheets. It tells us how much wealth households have relative to available income. Over the last 25 years, this measure has averaged about 5.17 (i.e. households, in aggregate, typically possessed in wealth their current disposable income multiplied by 5.17). In late 2006, this ratio peaked at a value of 6.36. It then fell to 4.6 at the beginning of 2009, as housing price declines and stock market declines eroded household wealth.

The personal savings rate tends to be negatively correlated with NW/DPI, rising as household balance sheets deteriorate and falling as they improve. In turn, the personal savings rate has an important effect on macroeconomic growth, with a rising savings rate holding back short-run growth due to declining household consumption.

The graph above plots the current value of NW/DPI (red line) and the 25-year average (1982-2007) (green line). The blue line charts the personal savings rate. Household net worth data are from the Federal Reserve’s Flow of Funds data and the savings rate and disposable income data come from the Bureau of Economic Analysis National Income Product Accounts.

Household balance sheet repair, meaning household deleveraging as families pay down debts and build up savings, continues as seen by the gradual upward trend of the NW/DPI since early 2009. However, there have been ups and downs in this process, which is crucial for successfully emerging out of a balance sheet recession. We are currently experiencing one such down period, given recent stock market declines. As of the end of the second quarter of 2011, NW/DPI currently stands at 5.04 (plotted on the right axis) and the personal savings rate ( left axis) has ticked up to 5.2%. 

It might be useful to see where we stand relative to our expectations from just a little more than a year ago. At that time, my estimate for the current value of NW/DPI was 5.11, somewhat higher than it is today. The estimate for the savings rate was 4.75%, 45 basis points lower than it is today. So while household balance sheets continue to heal from the damage caused during the Great Recession, they are doing so more slowly than expected a year ago.

At the current post-2009 pace of NW/DPI growth, household balance sheets should return to their historical average by the end of the first quarter of 2012. It is not unreasonable to expect NW/DPI to continue to grow higher than this average given more pronounced aversion to financial risk that exists today. But as the ratio rises, the personal savings rate should continue its downward trend, perhaps to 4%. This will increase consumption growth and allow for more job creation and economic growth.

Finally, to give a sense of what has changed in terms of household net worth and balance sheets, data from the Flow of Funds indicates that since 2007:

– Outstanding total mortgage debt is down 5.76%

– Outstanding consumer credit is down 5.16%

– Household net worth is down 9.03%

– Homeowner equity is down 39.62%

– The share of equity relative to the value of owner-occupied housing has fallen from 49.5% in 2007 to 38.6% for the second quarter of 2011



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