US Household Deleveraging: Finance vs Fear

Three charts today which show how far US household sector deleveraging has already gone – back all the way to the realms of ‘normality’ and, in some ways, beyond. It leads to a powerful conclusion: deleveraging is no longer about the sustainability of balance sheets or even current spending patterns. Rather, it’s now about fear of what the future may bring. Or to be more precise: fear of unemployment.

This first chart tells us about the overall size of US net household balance sheets in comparison with the size of the economy.  At the end of June US households had net financial assets of US$32.38 trillion, equivalent to 235% of GDP. That size looks about right, with little or no further adjustment needed, by two counts. The first measurement is made simply by extrapolating the gradual rise in the household sector’s net financial assets as a percentage of the economy between 1978 and 1994  - ie, in those years after the conquest of inflation but before the roaring bull markets of the mid/late 1990s and the asset bubbles inflated after the financial crashes of 1997/98.  (For reference, the S&P ended 1994 at 459.) If things had simply gone on like that, we’d expect household net financial asset to have reached around 226% of GDP – vs the 235% we see currently. To get there would take a fall of 3.6% in net household assets and no change in GDP – personally I’ve no doubt we’re already there.  The second measurement is simply the average around which this ratio has oscillated so wildly since 1995 – it comes out at 233%.

I think it reasonably safe to believe that, cyclical fluctuation notwithstanding, the  structural adjustment made in the size of US household balance sheets relative to the economy has substantially been made.  Or more bluntly, the US household sector is about as wealthy as you’d expect.

But what about the mortgage debt? How heavily is that likely to be weighing on households savings/spending decisions?  The second chart looks at mortgage debt in proportion to the total holding of net financial assets. If this is very high, one might anticipate a reluctance on behalf of households to raise mortgage debt faster than their overall balance sheets.   And indeed, we see that this ratio has crumbled from a 1Q peak of 40.9% to 28.2% at end-2Q11 – a level which was sustained unchanged between 2002 and 2007.

It may therefore seem reasonable to see this as a point of stability, at which the urgency of cutting mortgage debt is relaxed somewhat in the minds of householders. If not, and we are looking for a full retreat to the pre-1992  financial norms, then the ratio needs to come down further, to 22%-23%.  If so, then at the post-crisis rates of adjustment, we can expect that to be completed within four quarter – ie, by June 2012. 

The third chart looks directly at the US household mortgage debt service ratio, which expresses payments on mortgage debt, home insurance, and property taxes, as a percentage of with disposable personal income. At end-June 2011, this ratio had fallen to 9.5%, the lowest reading since 2003, and down from a peak of 11.3% in 3Q2007.  More, this is now lower than the 1980-2011 average of 9.6%, or the average since 1995 of 9.7%.   It is also lower than at the start of the period of aberrant financial behaviour (when households started running down net deposits, rather than building them up) in 1991. 

There is a simple and irresistible conclusion to be drawn from these charts: by the standards of the financial history of the last 30 years or so, we ought now to be coming to an end of US household sector deleveraging.  Demonstrably:

1. the household sector’s net financial situation is about where history suggests it should be;
2. mortgage debt as a percentage of net financial assets has already retreated to recently ‘normal’ levels, and on current trajectories will have returned to long-term ‘normal’ levels within a year. And
3. mortgage debt service ratios are already below long-term averages.

And from this one can draw one further conclusion: that continued and sustained debt deleveraging by the US householder is based not on the discomfort of the current situation, but fears about deteriorating future prospects.  Jobs and job safety, in other words.