The Big Idea
A picture of health for household finances
Stephen Stanley | January 6, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Last month, the Federal Reserve released the Financial Accounts of the US for the third quarter of 2022, a report that includes data on household balance sheets. This offers a good opportunity to survey the condition of household finances heading into 2023. The data suggest that households were still, in the aggregate, in good financial shape.
Those who have been reading my economic analysis should be familiar with the series I call “household liquid assets. It is the sum of households’ holdings of currency, bank deposits, and money market fund shares reported in the Financial Accounts. These are readily spendable resources, dry powder for the consumer.
The trillions of dollars of fiscal largesse handed out in 2020 and 2021 as well as extraordinary saving during the pandemic, which limited opportunities to spend on certain activities like travel, resulted in an unprecedented run-up in household liquid assets.
One of my highest conviction themes heading into 2022 was that this reserve would sustain consumers, even in the face of what turned out to be rampant inflation. In particular, I presumed that as soon as the pandemic lifted and people were allowed to congregate and travel freely, we would see a massive surge in consumer spending. Some commentators have tabbed this concept “revenge spending”.
In fact, this did not happen. There were widespread reports of packed airports during the summer, and it does appear that the demand for travel services was unusually robust. But overall consumer spending never managed to pop to the extent that I had expected. There is good news and bad news in this surprise. The bad news is that the economy proved far more lackluster last year than I had anticipated.
The good news is that households by and large held on to their extraordinary pandemic-driven liquidity buffer. The pre-pandemic trend for this series worked out to annual increases of about $500 billion. In 2020 and 2021, household liquid assets surged by roughly $5 trillion, suggesting that consumers had about a $4 trillion extra cushion. Judging by some of the gloomy commentary written about the consumer last year, one might think that this buffer had been entirely gobbled up by inflation. However, the latest figures show that after peaking in the first quarter at $18.5 trillion, this series has barely inched lower. As of September 30, households still had $18.4 trillion in liquid assets, down by a mere $133 billion over the second and third quarters (Exhibit 1).
Exhibit 1: Household liquid assets remain high
Barring a disastrous fourth quarter, consumers entered 2023 still holding a massive backstop of liquidity to sustain their spending, a key reason that I do not agree with the consensus call for a mild recession in early 2023.
A few months ago, I wrote a piece on the additional detail offered by the Fed on liquid assets by income distribution. At that time, the data through the second quarter of last year showed that the liquid asset position for households with income in the top four quintiles was broadly consistent with the aggregate numbers (a run-up and then a flattening at inflated levels). In contrast, for those in the bottom quintile, liquid assets plunged in the second quarter and had reversed almost all of the 2020 and 2021 runup. However, the third quarter release showed a big revision. The most up-to-date figures show that liquid assets remain elevated for all five income quintiles. In fact, the results are remarkably consistent from the top of the income scale to the bottom. For all five income quintiles, liquid assets surged in 2020 and 2021 and have been close to flat in the spring and summer.
On the other side of the balance sheet, while assets remain inflated, household debt has not backed up as a proportion of GDP. The ratio of household debt to GDP has fallen for seven straight quarters through the third quarter and is below 75% for the first time since 2001 (Exhibit 2). There has been some talk about a run-up in credit card debt in 2022, but the aggregate data do not suggest that households are becoming overly indebted.
Exhibit 2: Household debt-to-GDP ratio suggests manageable levels of debt
Another angle to examine is the cost of servicing household debt. Interest rates are obviously higher than they were before the pandemic, so even an unchanged level of debt could impose a greater financial burden on families. However, the Fed’s data on debt service payments and financial obligations as a percentage of disposable personal income show that, at least through September 30, debt service is not imposing a damaging burden on households.
Just to define the variables, debt service payments include required monthly payments on various types of closed-end loans—mortgages, car loans and the like—and, for revolving debt, 2.5% of the monthly balance. The financial obligations ratio includes debt service plus rent payments, auto lease payments, homeowners’ insurance and property tax payments.
These ratios have increased in 2022 as rates have shot up but are roughly back to where they were just before the pandemic (Exhibit 3). The current levels are near historical pre-pandemic lows. These series are worth keeping an eye on since debt service costs are likely to continue to rise along with interest rates. In particular, I am not sure how the Fed is handling student debt during the moratorium, so it will be interesting to see what happens when the dust clears on President Biden’s student debt forgiveness and the pandemic moratorium finally expires.
Exhibit 3: Debt service and financial obligations ratio
A picture of health
Household finances from a variety of angles look exceedingly healthy. Certainly, the most important fundamental for the consumer at any point in time is employment. With the unemployment rate below 4%, households are likely to spend relatively freely for the time being. On top of the solid income growth being generated by a robust labor market, households are sitting on a still-formidable reserve of assets, have limited debt, and are not stressed at this time by their debt service burdens.