View Full Version : U.S. Household Sector Not as Bad Off as Commonly Believed

12-12-2008, 12:56 PM
Doom and gloom, doom and gloom. Bah. Humbug. I've been feeling some optimism in the past week.

December 10, 2008

J.D. Steinhilber

It is clear that the government is going to do whatever it takes, through monetary and fiscal policy, to break the recession and debt-deflation dynamics at work in the economy and the markets. The new Administration will implement a massive fiscal stimulus program, and the Federal Reserve, in addition to holding policy rates near zero for an extended period, will continue to pursue unconventional programs aimed at jump-starting credit markets and liquefying credit providers.

In short, the government is getting ready to prove the thesis articulated by Chairman Bernanke six years ago that deflation is reversible under a fiat (i.e. paper-based) money system, provided the government is sufficiently determined and creative. It is puzzling that so many seem to doubt that premise and are pricing assets as though the economy were headed into a protracted (i.e. multi-year) deflation.

It may take some time, but it seems clear that the government will create sufficient quantities of money to cause money to be worth substantially less in the years ahead. Cash (and Treasuries) may be king for the moment, but will prove to be poor investments in that environment. The pessimists, who today have the upper hand, believe that the economy is hopelessly trapped in a deflationary bust, but this is an overstatement of the debt problem. The worst excesses of the credit bubble were in the financial sector. We have all watched that spectacular collapse of leverage on Wall Street and are now in the process of rebuilding a sounder financial system.

However, the deflationists argue that the U.S. household sector, which is a far more important driver of economic activity, also grew hopelessly addicted to debt and are now caught in a terrible “liquidity trap.” This is an exaggeration, so I find myself in the unfamiliar position of arguing that the U.S. household sector, despite having just suffered an historic hit to net worth, is not nearly as bad off as is now commonly believed.

Consider two facts concerning leverage at the household level. First, the U.S. government publishes debt service coverage data for the household sector, including a statistic called the “financial obligations ratio,” which captures not just required payments on mortgage and consumer debt, but also automobile leases, homeowner’s insurance, and property tax payments. From 1980 to the present, for U.S. households in the aggregate, all of these obligations as a percentage of disposable income have grown from 13.8% to 17.5%. This is a significant increase, but hardly catastrophic. Many households locked in historically low long-term mortgage rates in the past decade and many households never took part in the debt binge at all.

Second, the bear market in the stock and real estate markets has caused U.S. household net worth to decline from a peak of approximately $58 trillion to an estimated current level of approximately $45 trillion. That is the largest hit in several decades, to be sure, but $45 trillion of net worth is still a VERY large number and helps to put the $14 trillion of current U.S. household debt in perspective. The greatest risk an investor faces at this point is how long and deep this recession will be. It may end up being the worst recession in the post World War II era. If that is the case, stock investors will have to deal with failed rallies and limited upside for a period of time. However, even in this scenario, it is likely that the November 20th price lows will hold because an outlook for significant further economic weakness is widely accepted and therefore likely reflected in market prices.

Alternatively, this recession may turn out to be not as bad as is currently feared, in which case a new cyclical bull market could get underway relatively soon. Whichever scenario unfolds, it is highly likely that long-term investors will be amply rewarded for holding and purchasing stocks at current depressed prices. Investors have endured one of the worst decades in history for stock market returns (a testament to how overvalued stocks became in the late 1990s and the dangers of debt bubbles).

From November 1998 to November 2008, the S&P 500 (SPY) has delivered a return of negative 0.9% per annum, representing a cumulative loss of 9%. The consolation for ten years of terrible stock market performance is that the next ten years are highly likely to be very rewarding. According to statistics compiled by the Leuthold Group, whenever trailing ten year annual returns have fallen to 1% or less (which has only happened following the great bear markets of the 1930s and the 1970s), the next ten years have produced an average cumulative return of 183%, and the worst subsequent ten year return was 101%.


12-12-2008, 01:02 PM
....One of the primary questions of the day is to what extent and how rapidly is the average consumer is using his massive commodity rebate towards rebuilding his balance sheet. This has a number of significant ramifications, including Joe Sixpack's future ability to service and payoff debt that is currently selling in the market in Panic mode.

There is little reason to wait around for the answer. For instance for one rebate item, gasoline, demand can be tracked every week. The gasoline price rebate is now up to $29 billion a month. It has been up and down, but overall it shows the Joe’s discretionary income is going somewhere else, and given other evidence on consumer spending it is nest egg building and debt paydown.


As if the massive commodity rebate is enough, now we are getting another late in the day reaction from the credit card companies to slash credit lines to Joe. At the same time these companies are moving to eat the garbage they hold, and are upping the collateral they provided for securitizations.

(Reuters) - The U.S. credit-card industry may pull back well over $2 trillion of lines over the next 18 months due to risk aversion and regulatory changes, leading to sharp declines in consumer spending, prominent banking analyst Meredith Whitney said. We expect available consumer liquidity in the form of credit-card lines to decline by 45 percent.”Bank of America, Citigroup, and JPMorgan Chase & Co represent over half of the estimated U.S. card outstandings as of September 30, and each company has discussed reducing card exposure or slowing growth, Whitney said.

Total credit lines on cards is $4.4 trillion, so a cut of this magnitude would drop this to $2.4 trillion, versus less than $1 trillion actually borrowed, so I am not exactly sure what all the unused credit line fuss is about. This is designed to handle aggressive card users in my book, and reflects prudent tightening. My guess is that many consumers could care less about this as they get a double rebate from paying this down anyway. They use their inflationary relief rebate funds to par down usury interest rates from credit cards which in turn gives them a extra defacto savings rebate. At this rate it won’t be long before Joe ain’t such a bad credit after all.

This is from an excellent (subscription only) blog by Russ Winter. You can read the "top line" here:


Highly recommended.

12-12-2008, 03:27 PM
Ignore 2/3 of the citizens, and everything looks good.

For their own sake, hopefully the top wealth/income 30% of citizens this article is talking to and about are as independent of the overall economy as they think they are.

12-14-2008, 01:05 PM
Some of this article is flat out BS, as bank repos and jingle mail on houses are counted as increased consumer liquidity.

Let your house get repo'd and yes, you will have more disposable income in non-recourse states.