Thursday, March 11, 2010

Households' balance sheet repair continues (2)

According to the Federal Reserve's calculations, the net worth of U.S. households as of last December had increased by $5.7 trillion (up 11.6%) from the low of last March. The gains came from a combination of higher equity and bond prices and reduced debt that overwhelmed declining real estate values. This reflects a healthy realignment of households' balance sheets (lower debt ratios, less reliance on real estate), as well as healthy improvement overall. However, it will take a few more years before households have recovered their peak net worth.

I note that the ratio of household's tangible asset holdings to total assets is now 33.7%, which is below the average of this ratio (36.6%) since records began to be kept in 1950 (see chart below). To me, this suggests that the correction in real estate prices has largely run its course. You might say that real estate is now somewhat "cheap" relative to financial assets. Think of the "tangible asset ratio" as a measure of how enthusiastic households are to own real estate instead of other sources of wealth such as stocks and bonds. Also note that the public's willingness to pay up for real estate is roughly correlated with underlying inflation, as the chart suggests. Tangible assets are a natural inflation hedge, so this makes a lot of sense. If inflation has bottomed out this past year and begins to rise in the years to come, then we could expect tangible asset prices to recover.


septizoniom said...

more people would be better off over the long term if house prices decline closer to long term trend. the federal government is thwarting that. that is a shame.

W.E. Heasley said...

Mr. Grannis:

Regarding household wealth in the realm of personal residence real estate, a lot has been written about the effect on consumption patterns produced by the loss in value/wealth of the personal resident premises. The headline is that the loss of wealth depresses consumption patterns.

However, there is really two patterns regarding personal residence value/wealth and current consumption.

Those folks who were planning on trading up and were semi speculative and highly leveraged or those who were flipping property and were speculators/highly leveraged are clearly impacted in the wealth/consumption pattern.

Conversely, those folks with little leverage and/or consider their personal residence a “homestead” and have no interest in trading up and/or moving, have a totally different consumption pattern regarding wealth.

The “homestead” person, even if leveraged and underwater on equity, is not as concerned by lower home equity as they are staying put. There consumption pattern is trumped by the “homestead” effect. Further, the “homestead” person with low leverage or no leverage (home paid for) is actually in a position to take advantage of the current consumption environment. They are in a position to take advantage of consumption in sectors with deflation or deep discounts. In other words, there is a segment of the “homestead” property owners that clearly benefit from the current consumption environment.

Unknown said...

EPFR data on GEM AUM just 10% below last peak, are consistent with above data which counts financial wealth ca 10% below max level.
But as you predict more interest for RE in the future, does this bode well for equities flows?
Moreover that a some flow to equities in last cycle was (probably) financed by Mortgage Equity Withdrawal.

Scott Grannis said...

Family: Mortgage equity withdrawal (MEW) can't really "finance" equity price gains, which can only occur if the market is able to discount higher future cash flows to corporations. MEW is better thought of as a decline in households' demand for money (i.e., rising borrowing is equivalent to declining money demand). Declining money demand is a natural response to inflationary monetary policy, as are higher prices for tangible assets.

Inflationary monetary policy, in turn, has rarely if ever been good for equity prices. I think equity prices are still likely to rise, however, even though monetary policy is inflationary, because valuations are still depressed. The market is still very worried about the economy and still very worried about deflation. Even a 20% gain in equity prices would leave valuations cheap, according to my model, which uses economy-wide corporate profits (NIPA profits).