Household Net Worth Declines

New data from the Federal Reserve Board confirm that household wealth fell by 4.5% in the third quarter of 2002 to its lowest level since 1995. Total U.S. household net worth was approximately $38 trillion. Assets fell 3.4% to $47 trillion (primarily due to a 17% drop in the value of stock and mutual fund holdings), while liabilities rose 2.2% to $8.5 trillion. Most of the increase in liabilities was due to growth in mortgage debt, which rose 3.3%, the fastest growth since 1989. The ratio of net worth to disposable income for the household sector fell to a seven-year low of 4.9 in the third quarter, as compared to 5.2 in the second quarter and its record-high of 6.3 at the end of 1999 (just before equity prices started to tumble).

Economists offer mixed opinions on whether the latest decline in wealth will dampen consumer spending going forward. Goldman Sachs economists William Dudley and Jan Hatzius believe there are still fiscal imbalances in the household sector that will continue to boost saving and dampen spending behavior. In short, at approximately 4% of disposable income, the U.S. personal saving rate is still too low. The rate is about half the post-war average, which was fine when stock prices were rising 20-25% a year. With stock prices and net worth down, households that want to see their wealth grow have to resort to saving more. But, stock values have been down for almost three years. How long does it take for this "reverse wealth effect" to materialize? The personal saving rate is clearly higher now than it was during the 1999-2001 period (about 2.5%). Still, why aren't households boosting their savings rate faster? Dudley and Hatzius think the answer lies in the unique combination of falling mortgage rates and rising housing values that have typified the past two years. Households refinanced mortgages with lower interest rates, and the rising value of their homes allowed them to cash out larger amounts of home equity, sustaining consumer spending. When interest rates stabilize, this party will be over. They write in their newsletter The Pocket Chartroom: "The message bears repeating: Even if house prices do not fall outright but merely stabilize, and even if interest rates do not rise substantially but merely level off, consumers are likely to retrench." Both seem likely in 2003.

They go on to distinguish their view from the more optimistic view prevailing among many Wall Street analysts. The optimistic camp maintains that "we have nothing to fear but fear itself." Consumers and business were cautious with their spending decisions in 2002 due to a combination of factors including accounting scandals, the threat of terrorism and the threat of war with Iraq. Once these uncertainties resolve, low interest rates and thin inventories will fuel a strong recovery.

In contrast, the Goldman Sachs economic research team believes that the fiscal imbalances described above (i.e., savings rate too low relative to household wealth) imposed a drag on household spending during 2002 and will continue to do so into 2003 until the imbalance is resolved.