Tuesday, June 12, 2007

Financial Condition of US Households

The Daily Global Commentary from the Northern Trust usually provides an interesting point of view. In Monday’s commentary they discuss the debt and liquidity position of the US household. Needless to say, debt is high and liquidity is low. The question is what numbers define the breaking point for US consumers where they cannot go on any further?

In 2007:Q1, total household debt represented 18.584% of the market value of total household assets – just off the record high of 18.684% set in 2006:Q3.

Unfortunately, I could not reproduce the graphs so you have to trust me on some of my approximations. Basically the total household debt to total household assets went from 6% to 15% in about 40 years (1950 to 1990). This same value remained at about 15% through the mid-1990s and then drop to about 13% by 2000. In 6 years time (since 2000) this same value has increased 42% to about 18.584%. The average household has "levered up" considerably and this value may get worse the value of home values begin to decline.

Households’ single-largest asset, their houses, is carrying record debt relative to its market value. I can’t confirm it, but conventional wisdom has it that about one-third of all owner-occupied housing has no debt associated with it. If that’s case, then with record leverage in housing today, the two-thirds of houses with debt associated with them must have an incredibly high debt-to-value ratio.

The total mortgage debt/market value of owner occupied real estate was about 18% in 1950, increasing to about 30% in 1982. Since that time it has risen steadily to about 48%. Once again this number will only get worse as the value of homes declines.

With total household leverage just off a record high, household liquidity, defined as total household deposits as a percent of total household debt, is just off a record low.

This value 1950 was about 160%. It fell to about 120% by 1960 and hung in that 120%-range until about 1983. Since that time it has fallen steadily to about 50% today.

As alluded to in an earlier post, the high level of debt and low liquidity is unchartered terrirtory for most organizations trying to understand consumer behavior. However, high leverage and limited liquidity is always a bad combination. In this case the US consumer has to keep working, to keep that income rolling-in, to keep all the balls in the air (servicing all that debt). Lose that income and the juggling act ends. Done on a large enough scale and personal consumption expenditure (PCE), the value accounting for 70%+ of the GDP value begins to drop, leading to an economic downturn and recession if the downturn is severe enough.

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