James Saft

SAFT ON WEALTH: The consumer finance mess

June 14, 2012

June 14 (Reuters) – 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 Financesshows we didn’t
just suffer a debt bubble – we had an income drought.

The statistics are stark: in the three years through 2010
the median family saw its net worth fall by nearly 40 percent,
wiping almost two decades of asset accumulation off of the
books. The real source of concern was a 7.7 percent 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.


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 percent 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

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 percent to 16.4

The good news was that the proportion of households where
debt repayments account for more than 40 percent 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 percent in 2001. Direct ownership of
stock declined by about 15 percent and ownership of stocks in a
fund fell sharply – by almost a quarter to just 7.7 percent.
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.

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