Recession Over? Household Balance Sheets Tell a Different Story

checkbook household balance sheetAlthough the Great Recession officially ended in June 2009, the strength and sustainability of the recovery is still in question. While the statistical pulse of the economy -- GDP, industrial production, personal income and retail sales -- have all risen smartly from the recessionary bottom in March 2009, the experience of the average citizen remains mixed: unemployment is still high, and there is a pervasive sense that the recovery is tepid at best.

One way to make sense of the question "is the recession really over?" is to look at the American household as a business. From this point of view, the household balance sheet is of paramount importance.

In a typical business-cycle recession, companies over-expand and take on too much debt. When income declines, they suffer a cash crunch, and must reduce expenses, capacity and debt and rebuild cash for future expansion. This is called repairing the balance sheet.

So the question becomes: have U.S. households repaired their balance sheets? If they haven't -- if they're still burdened by excessive debt, low cash reserves and stagnant income growth -- then the "end of the recession" loses much of its promise of solid recovery.

Skewed Income Growth

There is another key factor at work in the household balance sheet: the wealth effect (also called the Pigou Effect). When income and household wealth (or perceived wealth, such as home equity) rises, then consumption tends to rise as well.

If we are richer, or even feel richer, then we spend more. We all saw this in action during the 2001-2007 housing bubble, when rising home equity encouraged households to borrow and spend freely.

The front-end driver of the wealth effect is income. Though aggregate personal income has nudged higher, rising from $10.4 trillion in 2007 to $11.3 trillion in 2010, most of this increase flowed to the top 5% of households. For the other 95%, income is down to flat, meaning the economy's recovery isn't being fueled by widespread higher incomes.

The back-end driver of the wealth effect is the balance sheet of assets and liabilities. If the household balance sheet has recovered, then the recovery may well have legs.

Count the Assets

The Federal Reserve issues a comprehensive financial snapshot of the economy called the Fed Flow of Funds Accounts. Within this is the Balance Sheet for Households and Non-Profit Organizations, which offers a wealth of data on households' assets and liabilities.

Let's start with total assets: all tangible wealth, financial assets, real estate, everything up to and including the kitchen sink.

Prerecession (2007), households and non-profits held $78.6 trillion in total assets. At the bottom in the first quarter of 2009, that fell to $65.7 trillion -- a decline of almost $13 trillion.

For context, that's roughly the size of America's annual GDP.

As of June 2010, the figure had bounced back a bit to $67.4 trillion: up $1.7 trillion but still down a substantial $11.2 trillion from pre-recession levels. Net worth -- assets minus liabilities -- is also still down, falling $10.7 trillion from 2007 to 2010.

Clearly, the recovery in assets has been weak.

Deposits -- cash in banks and money market funds -- actually rose in the recession, suggesting households were turning other assets into cash:

· December 2007: $7.4 trillion
· March 2009: $7.9 trillion
· June 2010: $7.5 trillion

How About Housing and Consumer Credit?

The primary asset for many U.S. households is the family home, so home equity plays a major role in the wealth effect. Mortgage debt has declined modestly, from $10.5 trillion to $10.15 trillion. While some of this reduction in real estate debt results from households paying down mortgages, the majority of the decline stems from defaults and write-downs by lenders.

One striking data point pops out: the tremendous increase in mortgage debt from 2004 ($7.8 trillion) to 2007 ($10.5 trillion) -- a rise of $2.7 trillion, or 35% in just a few years. In the years since the bursting of the housing bubble, mortgage debt has barely budged. That suggests households are still shouldering heavy debt loads.

The net result of stubbornly high mortgage levels and lower home valuations can be seen in homeowner's equity, which has fallen from $13.1 trillion in 2005 to $6.9 trillion in June 2010 -- a drop of $6.2 trillion.

While home equity has risen $700 billion from the March 2009 low, the $6 trillion hit to U.S. homeowners' balance sheet is a stark reminder of the long-term consequences of heavy real estate liabilities and lower real estate valuations. Owner's equity as a percentage of household real estate hovers at 40%, down from almost 60% in 2005.

As for consumer credit, one important reflection of retail sales and the wealth effect, it has barely budged from $2.5 trillion in pre-recession 2007 to $2.4 trillion in June 2010.

The Foundation Still Has Cracks

Some observers are now suggesting that U.S. households have not really repaired their balance sheets, which may in fact be getting worse. According to the Fed and the Federal Deposit Insurance Corporation, banks and other lenders wrote off $588 billion in mortgage and consumer loans from 2008 to 2010. The Fed Flow of Funds reports that total household liabilities -- bank loans, mortgages, credit card balances, etc. -- have declined from $13.8 trillion in 2007 to $13.4 trillion, a drop of $400 billion. If lenders wrote off almost $600 billion, yet liabilities only dropped by $400 billion, then it appears households actually added $200 billion in debt.

As I argued back in April (see "Why the Deleveraging of U.S. Households Matters"), the massive decline in home equity removed a key prop from American homeowners' borrowing and spending. While home equity has risen modestly recently, it is still down $6 trillion from its peak. With increases in incomes concentrated in the top strata of households, there is neither the collateral nor increased income to support further borrowing or spending.

So it looks like household balance sheets have a long way to go until they are looking healthy again. Put together still-lofty levels of debt and extremely modest bounces in net worth and income, and you get a shaky foundation for a sustained recovery.

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audit the federal reserve, get rid of the IRS, reduce government spending by 50%. That would be a good start to a recovery.

September 23 2010 at 10:03 AM Report abuse +2 rate up rate down Reply

When the economic s**t really hits the fan, (and the worst hasn't happened yet by a LONG SHOT), you won't be discussing Obama or any political party. You will be trying to understand and pay for food and fuel and energy that has tripled or quadrupled in price. You'll be too busy wondering how it could get to this point, you won't have time to squabble over who you voted for and who is to blame. There is no president or person who can prevent this, not if they continue to only serve big money and the world elites.

September 23 2010 at 5:37 AM Report abuse +2 rate up rate down Reply

If you want a scary wake-up call as far your own investments or retirment accounts are concerned, you as Americans need to understand that the Dow Jones is over-valued by about two-thirds. It should in reality be at about 3,500 or perhaps 4,000. You tell most people that and their eyes glaze, they have no clue what that means. It's riding a credit and borrowing and growth bubble that it's been riding it since the late 90's..and it's current "value" is horribly inflated...and when it bursts, and energy costs spike again, you will see your investments and your 401ks, and your own personal finances plummet like nothing in history. There hasn't been a recovery, its a lie. Recovery for whom? The top 5%? They didn't experience or feel the recession in the first place. They were all the owners of companies who continued to make money and keep more for themselves.

September 23 2010 at 5:29 AM Report abuse +1 rate up rate down Reply

This isn't just about American recovery or recession. This is global. I just looked up some info on the state of England's current economic crisis. They are currently paying the equivalent of $6.82 for a gallon of gas. Yes, you heard me right, $6.82. Home heating fuel is even worse. This is going to happen here, it's just noone believes it. This recovery that supposedly happened is false. The world economy is in decline, and energy will continue to become more expensive, the US is not immune, we are tied right into this. The days of $2.50 or $3.00 gasoline will seem like the good old prosperous times.

September 23 2010 at 5:13 AM Report abuse +1 rate up rate down Reply
1 reply to mrgrant1863's comment

Also don't forget England and many other countries have been paying that and much higher for gas for decades. they were at over $5 when i was in high school in the 90's.. the world is screwed and its only going to get worse. the government hired company who put this report out are either idiots, have no touch with America or were told what outcome to write by the president.

September 23 2010 at 10:53 AM Report abuse +1 rate up rate down Reply
dc walker

15 million Americans out of work, has anyone talked to them??

September 22 2010 at 9:37 PM Report abuse +2 rate up rate down Reply

Hmm interesting poll just out, according to bloomberg 53% of foreign investors think Obama's economic policies are just whats needed but only 13% of American investors feel that way...So the people who compete against us like Obama and the people who invest in our jobs don't.....That kind of thinking explains why most NFL team owners think the Cleveland Browns coach is headed in the right direction, well at least for them that is........

September 22 2010 at 7:20 PM Report abuse +2 rate up rate down Reply

wasnt the issuing of sub prime mortgages kinda like the same as giving tax credits to homebuyers ? i mean it kinda makes it seem like they are going to be able to afford it..and in the long run...they cant

September 22 2010 at 6:56 PM Report abuse +4 rate up rate down Reply

Nobody really thought that the Bamster would admit that we are still having serious problems economically, did they? Let's create a few more gov't jobs--just like selling cheeseburgers to each other as far as creating new wealth.

September 22 2010 at 6:53 PM Report abuse +2 rate up rate down Reply

My local property taxes here in ny are going up 485..the strange thing is....when the prices of homes decreased by up to 30%..My taxes never went down...I got nothing extra then for my tax money, and I will receive nothing new with the increase, except that I will be keeping all those people that work for the local government in jobs for a longer period of time...while those who lost their non government jobs are still out of luck....and to extend the unemployment benefits even more !!! LUDACROUS...where is the "want " for these people to get back to work.....the extensions have gone way to far...and people are definately abusing the system..while everyone else is being charged the bill (there are some people out there who are hit hard by the bad times, i am not saying ALL unemployed fit my description)...for those of you who are HONESTLY looking for work..i wish you the best of luck!!!

September 22 2010 at 6:52 PM Report abuse +2 rate up rate down Reply
1 reply to wurkinman1's comment

meant 48% ...above

September 22 2010 at 6:52 PM Report abuse rate up rate down Reply

If prices can be raised why cant they be lowered, i think that would solve the stupid economy problem, people will spend if prices are lower, or is that to easy.

September 22 2010 at 5:46 PM Report abuse rate up rate down Reply
1 reply to gmini10's comment

Are you kidding me?

September 22 2010 at 8:20 PM Report abuse rate up rate down Reply