Q4 2010 Flow of Funds: Household leverage down, wealth effect dead, and equities surge

The Federal Reserve released the Q4 2010 Flow of Funds Accounts for the US. On the household balance sheet, net worth (total assets minus total liabilities) was estimated at $56.8 trillion, which is up $2.1 trillion over the quarter.

Notably, household net worth has increased $6.4 trillion since the recession’s end (Q2 2009). Moreover, personal disposable income increased another $918 billion over the quarter, which dropped household leverage (total liabilities/disposable income) 1.1% to 116%.

Personal saving as a percentage of disposable income rose markedly in Q4 2010 to 10.9% (based on the BEA’s measurement of saving using flow of funds data – see Table F.10, lines 49-52).

The chart above illustrates the the wealth effect – the wealth effect is the propensity to consume (save) as wealth increases/decreases. In the Flow of Funds data, this is best approximated by the ratio of net worth (wealth) to disposable income. In Q4 2010, wealth rose 0.15 times disposable income to 4.9, while the saving rate surged 6 pps to 10.9%.

I conclude from the near-term times series illustrated above, that the wealth effect is very weak, and the incentive to save outweighs the desire to consume one’s wealth. Better put: households are increasing consumption, but that’s due to increased income not wealth.

Of note, since 1997 the volatility of household net worth to disposable income is near 2.5 times that which preceded 1997. Households are fed up; and at least for the time being, the positive wealth effect may be effectively dead.

As an aside, I put something out there: the ‘measure’ of saving is becoming increasingly unreliable. Spanning the years 2008-current, the average discrepancy between the Flow of Funds measure of saving and the BEA’s measure of the same definition of saving (the NIPA construction) is more than 2 times what it was in the 2 years leading up to the recession. This is worth more investigation; but historically, the FOF measure (the change in net worth) has been more reliable.

Breaking down household assets from liabilities, you see what’s driven most of the cumulative gain in net worth: financial assets, which are up near 16% since the recession’s end. During the recovery to Q4 2010, pension fund assets are up 22%; mutual fund holdings gained 32%; and here’s the Fed’s baby, corporate equities (stocks) surged 41% (and more, of course, since this data is truncated at December 2010). Credit market instruments are up 6%.

The asset gains outweigh the drop in liabilities, as mortgages and consumer credit have dropped near 4% and 2%, respectively, since the end of the recession. Consumer credit is making a comeback, though, growing 1% over the quarter, while households continue to reduce mortgage liabilities.

I will comment sometime over the weekend or next week about corporate excess saving, which also is constructed using the Flow of Funds data.

Rebecca Wilder

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