Monday, 24 September 2018

The US consumer finance mess

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It won’t be the American consumer who powers the economy and financial markets. An examination of the Federal Reserve’s new tri-annual Survey of Consumer Finances shows the US didn’t just suffer a debt bubble – but an income drought.

James Saft, Reuters Columnist

The statistics are stark: in the three years through 2010 the median family saw its net worth fall by nearly 40%, wiping almost two decades of asset accumulation off of the books. The real source of concern was a 7.7% drop in real income in the period, leaving many families still struggling with intractable debts.

There are two really important takeaways from the survey.

First, U.S. households, far from being a source of real pent-up demand, are sailing into their retirement years with very little wriggle room. Saving has been deferred, yet again, and consumption will have a very difficult time driving growth.

Second, and unsurprisingly, the poor and volatile performance of equities during the bubble years has driven savers away from the asset class, setting them up for another potential disappointment.

The root cause of the financial crisis, it seems clear from the data, was the interplay between stagnating family income and the easy availability of debt. The debt not only bankrolled consumption by heavy debtors, it – and this is an important point – encouraged consumption by those who had manageable or no debt at all.

That’s because the flow of debt through society helped to elevate asset prices, both in housing and in stocks and bonds, allowing many more people to play at being wealthy types who live off of their investments. What we saw from 2007 to 2010 was this: as the air came out of the debt bubble, the impact spread, hitting asset prices and income.

It is this interplay that is key, and it is ongoing. In fact the loss of notional wealth, which was mostly due to the fall in the value of housing, really should be thought of as the lifting of an illusion.

Americans thought that somehow their houses and stocks could go up and up and finance lifestyles their earned income could not. What’s more, a lot of the earned income – think about sectors like finance, construction and real estate – were artificially raised by the debt bubble.

The long stagnation

Wages and income in real terms have been stagnating for decades. Putting aside arguments about the justice of this, it presents a real problem for investors in an economy which relies on consumption for 70% of its activity. A loosening of lending standards allowed the economy to grow reasonably strongly until the crisis, but the math is now far less favorable.

Debt went down in absolute terms, according to the Fed study, but rose by the key comparison to net worth. For all families, the ratio of debt/net worth rose by 11% to 16.4%.

The good news was that the proportion of households where debt repayments account for more than 40% of family income – in other words those drowning in debt – fell.

That’s probably partly the result of borrowers defaulting on home loans. In aggregate, debt to family income levels continued to rise, despite falling interest rates and despite a huge wave of defaults.

The savings rate, as measured by the survey, also fell, raising questions about exactly how long retirement saving can be forestalled.

All in all it was a survey only a bond investor could love, pointing as it does to years of sub-par growth and little room for reflationary growth.

People’s faith in the stock market has been eroded by the bubble and bust pattern, as can be seen in the decline in the number of families with exposure to stocks, which declined to less than half from 52.3% in 2001. Direct ownership of stock declined by about 15% and ownership of stocks in a fund fell sharply – by almost a quarter to just 7.7%. Fewer people also own retirement accounts, presumably due to emergency liquidation and slow uptake among the young.

While it is hard to get excited about equities in this climate, I can’t help but worry that this kind of mass turning away from the asset class is a buying signal. It would be a terrible irony if investors learned the wrong lesson from the past 10 years. It may be true that investors rarely get a fair shake from financial markets, but it is also true that, correctly done, they represent the best game in town.

So, stay invested, cut costs but don’t count on a consumer renaissance to inflate us out of our problems.

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

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