AMERICANS GET POORER MORE SLOWLY / BARRON´S

FRIDAY, JUNE 12, 2009

UP AND DOWN WALL STREET DAILY

Americans Get Poorer More Slowly

By RANDALL W. FORSYTH

As losses slow to just $1.3 trillion, the need to rebuild wealth will weigh on spending.

THE RICH ARE DIFFERENT FROM YOU AND ME, F. Scott Fitzgerald famously observed. This time, the wealthy have not been immune to the travails of an economic downturn, which in past cycles have fallen mainly on labor.

According to just-released Federal Reserve data, U.S. household wealth fell by $1.3 trillion in the first quarter, blessedly less than the previous three months' $4.9 trillion loss, the biggest quarterly decline since such records started being kept all the way back in 1952. But it was the seventh straight quarter of declines, also a record for the series.

Unlike past bear markets, there has been nowhere to hide. As stocks continued their plunge until early March, house prices have headed only in one direction,which is down.


And unlike pervious bear markets, such as after the tech-stock bust or the 1987 crash, Treasury securities didn't rally but lost value. Also in contrast to the bear markets of 1970s and early 1980s, when money markets provided reliable double-digit yields, cash either yielded nothing for safe T-bills or even lost value as money funds "broke the buck."

It's no news that the plunge in home prices continued unabated. But in past cycles, when stocks suffered their usual declines, residential real estate would only increase at a slower rate -- a fall in the now-familiar second derivative, or the inverse of the current "green shoots" phenomenon.

Indeed, household wealth is down $13.8 trillion from its peak in the second quarter of 2007, as Michael Feroli of JP Morgan Economics observes. But if the stock market manages to hold its gains through the June 30 -- and the Wilshire 5000 is up $3.4 trillion since March 9 -- this quarter could show the first increase in eight.

As of the end of the second quarter, the wealth bubble that began to inflate in early 1990s had been deflated. The ratio of household net worth to personal disposable fell to 4.67 times, the lowest since the third quarter of 1992, near the end of the first George Bush's term.

Back then, Feroli points out, the personal savings rate was 7.3%. In the latest quarter, the savings rate recovered to 5.7%. Savings actually had turned negative as Americans bought into the delusion they could borrow their way to wealth. Why save if you could treat your house as an ATM?

As the bubble burst, households were hunkering down, paying off debt, boosting savings and in the process sharply increasing their purchases of Treasury securities. Indeed, note Ira Jersey and Tom Porcelli of RBC Capital Markets, American households' purchases of Treasuries vaulted to $1.2 trillion in the first quarter, topping buying by foreign investors.

Nonfinancial debt expanded at a 4.1% annual rate in the first quarter, down from 6.2% in the preceding quarter. But the increase in debt was attributable entirely to the 22.6% annual rate of increase in federal debt.

The household sector meanwhile continued to deleverage, at a 1.1% annual rate versus 2% in the preceding quarter. The repair of household balance sheets, note RBC's Jersey and Porcelli, "is in part taking place through some combination of households taking it upon themselves to clean up credit lines and through banks closing for them."

Adds JPM's Feroli: "Delinquent liabilities of the household sector are not removed from the household balance sheet until the foreclosure process is completed, so measured household debt should continue to move down in coming quarters as mortgage delinquencies go through the foreclosure process."

Deleveraging -- paying down debt and boosting savings -- will continue to weigh on consumer spending even after employment and income eventually turn up, which is still far away. That's what makes this cycle different from the ones before.


In the past, the hits to wealth were concentrated in equities, which were held mainly by the well-to-do. And they were cushioned by their real estate, private business holdings, fixed-income securities and ample cash. In the bubble, however, even the rich got into hock with multiple homes that they now can't afford to carry and can't unload. There are only so many potential buyers for multi-million-dollar manses in gated communities.

But the household sector in past cycles was generally in surplus as a net saver and lender to business and government. All it would take to jump-start a new cycle would be for the Fed to cut interest rates, which would lower mortgage costs and spur housing. Aiding the process would be the government mortgage enterprises, Fannie Mae and Freddie Mac, which could be counted on rev up housing further.

Now, with wealth falling and households needing to rebuild their finances, monetary and fiscal stimuli are like throwing matches on so much wet wood. Only time can fix things.