Saturday, December 10, 2005

The Flow of Funds Report

This Thursday, the Fed released the "Flow of Funds" report for the third quarter. It shows that the trend of the last few years of asset price inflation and a higher debt burden continues . At $11 trillion, household debt is now at a record high of 121% of disposable income, up from 77% when Alan Greenspan became Fed Chairman in 1987. Mortgage debt alone have risen to 91% of disposable income, versus 52% in 1987.

On the other hand, household assets have also risen and while relative to disposable income they are still below the peak after the bursting of the tech stock bubble in early 2000, they are risen from 1987 (albeit not as fast as debt).

Some Administration pundits try to reassure us by telling those that worry about debt being based on a house price bubble that it is not just housing values that have risen, but that financial assets have risen too. But given that financial assets like stocks or mutual fund or pension fund shares are actually even more likely to see outright falls in value (That is what they did after the tech stock bubble bursted) than real estate, this hardly is very reassuring.

If current asset prices can be sustained then current debt levels can certainly be justified (at least on a aggregate level). But since the underlying value of assets must ultimately be derived from national income and since asset values relative to national income are at recorde levels, this means that there is a substantial risk that asset prices could fall again just like they did after the tech stock bubble bursted.


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