Households' balance sheets continue to improve

The Fed recently released flow of funds data for the second quarter, which includes an update to Household's Balance Sheet. The decline in real estate prices has reduced the value of real estate holdings by about $1 trillion in the past year. However, this loss was more than made up for by a $5 trillion surge in the value of total financial assets and a modest decline in liabilities, resulting in an increase in net worth of $4.4 trillion over the past year. Most of the gains in financial assets have come, not surprisingly, from equity holdings and pension reserves. Despite the fact that the equity market at the end of June was still down about 15% from its 2007 highs, financial assets were only down about $2 trillion from their highs, or about 5%—a testimony to household's ability to add significantly to their savings.

It's also interesting to note that over the past year, households have reduced their holdings of Treasury securities from $1.15 trillion to just $0.84 trillion, despite the $1.3 trillion increase in Treasury debt over the same period, reflecting the important role that foreigners have been playing in financing our huge federal deficit (which, if Treasury yields rebound, may prove to have been a wise move on the part of households, and an unwise move on the part of foreigners). Another important story here is that households have been deleveraging—liabilities have declined by almost $1 trillion over the past four years—as they have been forced to adjust to lower home values, and it has been very painful. Nevertheless, it is encouraging to see that households' equity as a % of real estate holdings, which peaked at almost 60% in 2005, was unchanged in the second quarter at 38.6%, suggesting that most of the downward adjustment is complete.