Friday, March 13, 2009

Flow Of Funds Report Contains Mostly Bearish News

Remember when various so-called supply-side economists such as David Malpass argued that the low savings rate and increasing debt level wasn't a problem because asset values kept going up?

Some of us pointed out at the time that in the long run, asset prices couldn't keep going up like that and that therefore it was not a sustainable substitute to real savings, and that these asset values could and most likely would turn down again, creating problems as the value of debt won't go down in the same way.

Yesterday's flow of funds report
confirmed (and expressed in more specific numbers) what we all knew-namely that asset values fell sharply during the fourth quarter of 2008, and that net worth thus fell back sharply. More specifically, it fell to $51.5 trillion, down $5.1 trillion in that quarter, and down a total of $12.9 trillion since the peak in the second quarter of 2007. It is now lower than in 2004 even in nominal terms, and if you adjust for inflation and population growth, the numbers are far lower than then.

Moreover, leverage, as defined by liabilities as percentage to assets, rose to a new all time high of 21.7%, up from 20.5% in the previous quarter, 18.6% a year earlier and 17.5% in 2004. That may not sound so high, but remember that this is an aggregate numbers that includes Bill Gates, Warren Buffett and all other billionaires and multi-millionaires that have hugh assets but little or no debt. The number of people with negative net worth is likely increasing fast as the value of their only asset, their homes, drop, while their debts stay unchanged. This is illustrated in how mortgage debt as a percent of home values, rose to 57%, up from 55.2% in the previous quarter and 42.1% in 2004.

And it should also be mentioned that home values in the Flow of Funds are based on the OFHEO house price index, which has dropped a lot less than the competing Case-Schiller house price index. While the Case-Schiller index probably exaggerates the house price decline, OFHEO likely underestimates them, meaning that the drop in home values and therefore also home equity (and overall household net worth and leverage) is underestimated.

The one positive item was that household debt has finally started to fall, while savings is up. This is a necessary first step to restoring sound household balance sheets. Just as asset values won't rise all the time, they are unlikely to fall forever (espeacially not at this rapid rate) and once they stabilize, this means that net worth can start rising again. However, there is still a long way to go before we've seen the end of this process.

Also, while household debt is down and savings is up, overall debt growth remains strong and net national savings is negative (though it did improve from the previous quarter). The primary reason for this is of course that the federal budget deficit reached record levels, something which also contributed to increasing growth in the federal debt. Also, while corporate debt growth has slowed significantly, it is still positive. And corporate savings, as defined by retained profits reached a new low of just $244 billion at an annual rate, down from $459 billion in the previous quarter and $703 billion in 2006. This is a result of the fact that while corporate profits have plunged, dividends have only recently started to drop and even now only moderately. And do note that this measure of corporate profits excludes writedowns. Had they been included, the numbers would have been even worse.

Overall, a quite bearish report in other words.


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