Relevant and even prescient commentary on news, politics and the economy.

Q4 2010 Flow of Funds: Household leverage down, wealth effect dead, and equities surge

The Federal Reserve released the Q4 2010 Flow of Funds Accounts for the US. On the household balance sheet, net worth (total assets minus total liabilities) was estimated at $56.8 trillion, which is up $2.1 trillion over the quarter. Notably, household net worth has increased $6.4 trillion since the recession’s end (Q2 2009). Moreover, personal disposable income increased another $918 billion over the quarter, which dropped household leverage (total liabilities/disposable income) 1.1% to 116%.

Personal saving as a percentage of disposable income rose markedly in Q4 2010 to 10.9% (based on the BEA’s measurement of saving using flow of funds data – see Table F.10, lines 49-52).

The chart above illustrates the the wealth effect – the wealth effect is the propensity to consume (save) as wealth increases/decreases. In the Flow of Funds data, this is best approximated by the ratio of net worth (wealth) to disposable income. In Q4 2010, wealth rose 0.15 times disposable income to 4.9, while the saving rate surged 6 pps to 10.9%.

I conclude from the near-term times series illustrated above, that the wealth effect is very weak, and the incentive to save outweighs the desire to consume one’s wealth. Better put: households are increasing consumption, but that’s due to increased income not wealth.

Of note, since 1997 the volatility of household net worth to disposable income is near 2.5 times that which preceded 1997. Households are fed up; and at least for the time being, the positive wealth effect may be effectively dead.

As an aside, I put something out there: the ‘measure’ of saving is becoming increasingly unreliable. Spanning the years 2008-current, the average discrepancy between the Flow of Funds measure of saving and the BEA’s measure of the same definition of saving (the NIPA construction) is more than 2 times what it was in the 2 years leading up to the recession. This is worth more investigation; but historically, the FOF measure (the change in net worth) has been more reliable.

Breaking down household assets from liabilities, you see what’s driven most of the cumulative gain in net worth: financial assets, which are up near 16% since the recession’s end. During the recovery to Q4 2010, pension fund assets are up 22%; mutual fund holdings gained 32%; and here’s the Fed’s baby, corporate equities (stocks) surged 41% (and more, of course, since this data is truncated at December 2010). Credit market instruments are up 6%.

The asset gains outweigh the drop in liabilities, as mortgages and consumer credit have dropped near 4% and 2%, respectively, since the end of the recession. Consumer credit is making a comeback, though, growing 1% over the quarter, while households continue to reduce mortgage liabilities.

I will comment sometime over the weekend or next week about corporate excess saving, which also is constructed using the Flow of Funds data.

Rebecca Wilder

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Private-sector leverage says that it’s not Bill Clinton

What’s your answer? “Thinking about the past few decades… to the best of your knowledge, which ONE of the following U.S. Presidents do you think did the best job of managing the economy?”

  • Bill Clinton
  • Ronald Reagan
  • Barack Obama
  • Lyndon B. Johnson
  • George W. Bush
  • Richard Nixon

That’s question #11 of the the Allstate-National Journal Heartland poll. 42% of the 1201 adults polled last month answered Bill Clinton.

I wonder why near half of those polled think that Clinton did the best job of “managing the economy”. Using one simple metric, private-sector financial leverage (accumulated dissaving), Clinton ranks among the top three worst economic managers, behind George Bush (Jr.) and Ronald Reagan.

The chart illustrates private-sector leverage as a stock of debt to GDP indexed to the start of each Presidential term. Therefore, the numbers are not the debt ratios, rather the appreciation of the debt ratios since the onset of each President’s term. The data are from the Fed’s Flow of Funds Accounts.

The sector financial balances model of aggregate demand posits that fiscal policy must shift in order to normalize GDP amid deviations of the private-sector surplus (desire to save) and the current account (see Scott Fullwiler’s article on the sector financial balances model of aggregate demand, which references similar work by Bill Mitchell and Rob Parenteau; or you can see last week’s answers and discussion to Bill Mitchell’s quiz for a simple outline).

When the private sector is levering up, the public sector is not doing its job. Since the 1990’s, the private sector loaded up on debt (ran private-sector deficits) in order to maintain GDP closer to full employment in the face of shrinking government deficits relative to those of the current account (since 1991 the current account trended down as a % of GDP). Deregulation, of course, contributed as well.

According to this metric, Barack Obama ranks highest to date, thanks to the automatic stabilizers and the ARRA. But we’ll see what happens when 2011 rolls around: the waning stimulus will drag economic growth; the Congressional tides may turn; and the immediacy of the crisis continues to fade. Unless firms start to “dissave” and pass on profits to households via hiring and wage growth, we may be in for a rocky ride, since the household desire to save will hover at very high levels for years to come (see David Beckworth’s post on the growing mismatch between mortgage debt load and real estate valuations).

Rebecca Wilder

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Household leverage: what does the US have that the UK does not?

Earlier this week I compared household saving rates across the US, UK, Canada, and Germany. My conclusion was pretty simple:

So generally, this simple analysis would suggest that Menzie Chinn’s skepticism of a “status quo” of US consumer imports is worthy. But with the status quo firmly in place in Germany, the household saving data paint a foreboding picture – certainly for the Eurozone, but possibly for the global economy as well.

The financial circumstances of US and UK households are very similar despite their diverging saving rates over the last two quarters (see saving rate chart here): leverage is high.

The chart above illustrates the total stock of household loans/debt (including non-profit organizations, which is small relative to the “household”) as a share of personal disposable income.

In the UK, household leverage peaked above that of the US at 161% of personal disposable income in Q1 2008, having fallen to 149% by Q1 2010. Furthermore, recent deleveraging by UK households has occurred through income gains, rather than paying down debt: spanning the period Q2 2009 to Q1 2010, the UK household stock of loans increased 1.2%, while disposable income grew 3.1% (you can download the data here).

Given the remaining leverage on balance, the divergence in household saving rates across the US and UK is probably not sustainable. The UK household saving rate is likely to increase, or at the very minimum, hold steady.

The problem is: that according to the sectoral balances approach, it’s impossible for the government and the private sector to increase saving simultaneously unless the UK is running epic current account surpluses (it’s not). Therefore, the £6.2billion in public “savings” may push UK households farther into the red. However, the more likely outcome is that UK public deficits rise amid shrinking aggregate demand (and with it, tax revenue) and the increasing household desire to save.

The punchline: the US household has something that the UK household does not: (still) expansionary fiscal policy ($26 billion in state aid and extending unemployment benefits, for example).

Rebecca Wilder

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The answer is the domestic private sector

Jim Hamilton used the Federal Reserve Flow of Funds data to present a question: who will buy “the additional $8 trillion in net new debt that would be issued over the next decade under the CBO’s alternative fiscal scenario.”

I thought that the analysis was curious and too “partial”. If one believes the deleveraging story, then domestic private saving is going to rise. The answer to his question seems pretty obvious…

Let’s say that consumption goes back back to the 1960’s-style 62% of GDP, then get ready for household Treasury accumulation. Spanning the decade of 1960, households held on average 30% of the Treasury’s liabilities.

A simple example illustrates my point. If the Treasury’s book doubles to $16.5 trillion, and the household share of Treasury holdings rises to 30% – as of Q1 2010 the stock of Treasuries outstanding was just about $8.3 trillion (see L.209 here) – then households will accumulate over $4 trillion of those new Treasuries. That’s just households, and holding all else equal (like financial funds and businesses).

So the answer is: the domestic private sector.

Rebecca Wilder

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John McWhorter on James Patterson and Some Odd Numbers on Black Childhood Poverty

by cactus

John McWhorter on James Patterson and Some Odd Numbers on Black Childhood Poverty

I’m kinda in the home stretch for the fact checking on my book – we’ve revised and rewritten and rechecked so many times I’m ready to plotz, but even so, I’m willing to bet some mistakes will creep in. Its inevitable in a book as data driven as this one. But I don’t like mistakes, so I recheck again…

Which brings me to this review of James Patterson’s new book by John McWhorter in the New Republic. The point of the book seems to be that welfare was bad for Black families. The review cites some interesting, er, facts, which presumably come from the book being reviewed.

For instance, after a few paragraphs about how welfare destroyed the Black American family, we’re told this:

As such, the refashioning of AFDC in 1996 into a five-year program with required job training was the most important event in black American history between the Voting Rights Act of 1965 and the election of Barack Obama. In that light, Patterson is too saturnine about the Moynihan’s report’s legacy. By 2004 the welfare rolls had gone down by two-thirds, and contrary to fears that people off the rolls would starve or languish in squalor (Moynihan was among those who thought they would), black childhood poverty went down to 30 percent from 41 percent, and ex-recipients have regularly reported greater self-esteem and are thankful for the new regime.

Well, if the 1996 refashioning yada yada yada “was the most important event in black American history between the Voting Rights Act of 1965 and the election of Barack Obama,” its something worth a look. Since I don’t have a clue where to find data on self-esteem and thankfulness, let’s have us a look at the bit about how, by 2004, “black childhood poverty went down to 30 percent from 41 percent.” We can check out data on Black childhood poverty from this table at the Census.

First, an aside – as of 2002, the Census started differentiating between two definitions of “Black” which is self-evident from the key to the graph above. Other things evident from the graph…. if something in ’96 caused a big drop in Black childhood poverty, it was powerful enough for its effect to work its way back in time all the way to ’93, which is the year Black childhood poverty began its decline. That drop did reach a bottom of 30.2%, but in 2001, not in 2004. In fact, unfortunately, the rate of Black children in poverty rose since then. And when the real facts are placed on a simple graph, its extremely difficult for a rational person to reach so and so’s conclusion.

Now, if this seems like someone was trying to bamboozle, there’s all sorts of “facts” like this in the review. Perhaps the one that is most frighteningly wrong is this one:

That momentous factor is this: After the 1960s, the percentage of black children with one parent exploded from a quarter to—by the 1990s—nearly three-fourths, vastly out of step with the availability of work, the prevalence of racism, or equivalent single-parentage figures for any other race.

Now, I should graph this, but I’m in kinda a hurry, so I’ll just let you know… data on the percentage of Black children’s living arrangements can be found at yet another table at the Census. One of the columns in that table gives you the total number of Black children, and another gives you the total number of Black children living with one parent. Using some of that fancy learnin’, I divide one column by the other and discover that….

1. 54.7% of Black children lived with a single parent in 1990.
2. That rate peaked (for the 90s) in ’96, at 57.4%, and then dropped to 53.3% in 2000.

Now, the ’96 peak might help make Patterson’s point… but if he made that point, its not in the review. (Of course, ignoring the ludicrous “three quarters” number isn’t an outright invention, giving Patterson the benefit of the doubt, what we would conclude is that he might be right about Black children living with one parent, but clearly not about Black children in poverty.)

Anyway, if McWhorter’s review is remotely accurate, call this an “unrecommendation” for Patterson’s book. And a suggestion to McWhorter – if the book cites facts that seem obviously false, check those facts. Because if the key points in a book are ludicrously inaccurate, that’s a big problem that should be mentioned in a book review. And agreeing with stuff that is just plain wrong makes no sense at all.

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Reducing household financial leverage: the easy way and the hard way

In case you haven’t noticed, I have become slightly less “optimistic” about the prospects of a sustainable U.S. recovery. I used to think that the household deleveraging story was more of a decade-long project, and the economy would cycle throughout. But recent deficit hysteria has me worried; income growth might lapse.

What differentiates this recovery from every other cycle since 1929 is the lingering debt deflationary pressures. There is a very large overhang of U.S. household financial leverage that’s going down one of two ways: the easy way, through nominal income growth, or the hard way, by default. Unfortunately, the hard way is rearing its ugly head.

The chart above illustrates private-sector financial leverage (debt burden). Not a surprise; but, the real leverage problem is in the household sector, and to a much lesser degree, the non-financial business sector. Household debt burden is the ratio of the debt stock (generally mortgages outstanding plus consumer credit) to income flow (personal disposable income), while “de-leveraging” is reducing this debt burden.

Given that the burden has a numerator (debt stock) and a denominator (income), de-leveraging can occur through either variable. As such, I see three (general) de-leveraging scenarios (See an earlier McKinsey study on the consumer for a broader discussion):

1. If there is no income growth, then households must manually pay down debt at the cost of current consumption. The consumption decline drags the economy, and some default results.

2. If income growth is positive, then the degree to which households must pay down debt at the cost of current consumption will depend on the pace of income generation. This is the most macroeconomically-benign scenario.

3. If income growth is negative, i.e., deflation, then real debt burden rises. 30-yr mortgage payments, for example, are fixed in nominal terms and become more difficult to meet as income declines. In this case, widespread default is likely.

Of course, these are just three broad categories, but I believe that my point has been made. Clearly, choice 2. is optimal. However, evidence is pointing to a de-leveraging process that is more of the 1. and/or 3. type, especially as the federal stimulus effects run dry (although I have noted before that there is room for error in the measurement of the income data).

The chart illustrates annual growth of disposable personal income minus annual growth of disposable personal income less government transfer receipts (DPI – DPIexT). The variable DPIexT proxies the personal income growth currently generated by the private sector only. Note: this is a calculated number, based on the BEA’s monthly personal income report (Excel data here). The spread has never been wider, 2.1% Y/Y DPI growth over DPIexT growth in February, spanning every recession since 1980.

The government is propping up income (as it should be). Spanning February 2009 to February 2010, DPI averaged 1.2% Y/Y growth per month, while DPIexT averaged -1.1% Y/Y per month. Further, since the onset of the recession DPIexT fell an average 0.03% M/M (over the previous month), while DPI grew 0.18% M/M.

The economy has crossed the threshold and is expanding – phew! However, without a burst of export income, it’s going to take a lot more than 123,000 private payroll jobs per month to free the economy of its fiscal crutch. (I debated whether or not to use the term “crutch” when applying it to fiscal policy because fiscal policy is not a crutch; but the metaphor works.)

Households WILL drop leverage further; it’s just a matter of how smoothly.

Rebecca Wilder

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US Flow of Funds: wealth recovery fully underway, China?

by Rebecca Wilder
(crossposted with Newsneconomics)

This week the Federal Reserve reported the Q3 2009 Flow of Funds accounts. The headline indicators show household net worth improving and private debt burden falling.

The private sector – households and firms – is dropping leverage.

Update: This chart has been modified slightly – the leverage level data (highlighted in blue, red, and green) has been updated.
Either by default or by growing saving, the private sector is de-leveraging. According to the D.1 table, households and nonfinancial businesses dropped debt a further 2.6% q/q annualized, while financial sector debt fell another 9.3%. However, total debt (of the domestic nonfinancial sector) grew 2.8%, as the federal and state and local governments grew debt 20.1% and 5.1%, respectively.

Household wealth grew $2.7 billion trillion for a cumulative gain of $4.9 billion trillion since wealth hit a cyclical low in Q1 2009. To put this gain in perspective, household net-worth dropped $17.5 billion trillion from Q3 2007 to Q1 2009, 3.5 x the recent gain. Wealth to disposable income, a statistically significant factor of the personal saving rate, rests right around it long-term (1952-1007) average, 4.9.

The chart illustrates the wealth-effect as the ratio of net-worth to disposable income. The direct and adverse impact of the wealth loss on consumption probably peaked last quarter; however, the lagged effects are ongoing.

Notice that the ratio shifted discretely in the 1990’s, not coincidentally when China’s current account surplus took off.

Most likely, the wealth to personal income ratio has mean-reverted, and will not rise back to its 5.7 1997-2007 average. A necessary condition is that global portfolio flows rebalance – i.e., China saves less and the US saves more. However, this will not happen tomorrow – de-leveraging is a process that takes years. The increase in international saving (i.e., falling current account deficits) will take some time, and by definition includes the general government eventually dropping its debt burden. Not to mention the political rhetoric and growing trade barriers suggest that a long-term economic shift is a ways off.

Rebecca Wilder

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