October 22, 2008 / 12:53 PM / in 9 years

Seven trillion reasons to expect a long winter:James Saft

<p>A worker drives a snow plough on the snow covered street of the Saint Gotthard mountain pass in the Swiss Alps September 14, 2008. REUTERS/Arnd Wiegmann</p>

-- James Saft is a Reuters columnist. The opinions expressed are his own --

By James Saft

LONDON (Reuters) - In a season with plenty of chilling numbers try this one: American households have lost something in the order of $7 trillion of wealth this year alone.

That ballpark estimate of the damage done to household balance sheets implies that spending will be cut back even more sharply than is already showing up in the economic data.

The debit side of personal balance sheets doesn’t look so good either; debt is tougher to get and more expensive and banks are increasingly asking for their money back where they can.

If you are in the real estate or automotive industries -- two sectors whose headquarters are at the intersection of confidence and debt streets -- you are very much out of luck.

But a real retrenching, one that takes savings rates back toward historical norms during a period of asset price deflation and higher unemployment, will leave very few parts of the consumer economy untouched.

Just as the banking and real estate crisis has been self reinforcing, so too will be the consumer downturn as belt tightening prompts layoffs and layoffs prompt belt tightening.

Regardless of who wins the Presidential election, further deficit spending, tax rebates and other forms of fiscal stimulus are all a good bet -- both to happen and to be not enough to break the cycle.

So, let’s look at those numbers.

Using end 2007 Federal Reserve data on household and non-profit organization holdings of real estate and equity-related assets, Thomas Lawler of Lawler Economic & Housing Consulting in Vienna, Va., applies a 15 percent year-to-date haircut to housing wealth and a 38 percent hit to direct stock, mutual fund and retirement account equity holdings to arrive at that lost $7 trillion.

It isn’t a pure number -- it includes nonprofit-making organizations and uses a mark-to-market from the very broad Wilshire 5000 index which has since recovered somewhat -- but it gives a sense of the scale of the hit to confidence.

People are stretched, and it is beginning to dawn on them roughly what that means.

Household debt hit 100 percent of GDP in the early part of this decade, since rising to above 130 percent. The personal savings rate, which was above 10 percent during the very difficult economic times of the early 1980s, fell and fell and was bumping along just above zero until the first quarter, before jumping to close to three percent in the second, despite the promise and partial arrival of checks from what will come to be known as the first stimulus plan of this recession.

DIMINISHING EXPECTATIONS

So, what is the evidence on how the double stock and real estate crash has influenced consumers?

They are saying they are gloomy and they are spending like they’d rather not leave the house.

The Reuters/University of Michigan survey of consumer confidence showed its steepest monthly drop on record in early October, registering one of its gloomiest readings since 1980. Retail sales dropped 1.2 percent in September, and are down 1 percent from a year ago.

Applying the Consumer Price Index of commodities to discount for inflation, real retail sales fell at a 12.5 percent annualized clip, the biggest such drop since 1980, according to Asha Bangalore, an economist at Northern Trust in Chicago.

David Rosenberg at Merrill Lynch points out that retail sales have now fallen three months running, a losing streak seen only four other times in the past five decades. Such a run of months has always been associated with a recession.

To be fair, the impact of wealth declines on actual consumer spending is not clear. Manoj Pradhan of Morgan Stanley in London reviewed studies on the impact of stock prices on consumption and found considerable variation, especially by region. He estimates, however, that a 32 percent fall in the S&P 500 index -- roughly equivalent to the fall so far this year -- could hit consumption by 1.9 percent over as long as three years, implying a decline in GDP of 1.4 percent.

Remember too that many investors will not have made much if anything in stocks in the past decade if recent lows are retouched. That being the case, it would not be surprising if average savers rethink what they can expect to make in financial markets over the long term.

That could well diminish flows to equities over the long run and drive savings rates rapidly higher, as people work out that capital gains alone won’t fund most retirements. Similar thinking is probably now happening among house owners who had hoped they could trade a big house for a small one in retirement and live off the difference.

“Academic economists are excited about the next few years, as they will be able to get a much better handle on how consumers respond to huge downward shocks in net worth, while retailers, automakers, and home builders are petrified,” Lawler wrote in a note to clients.

-- At the time of publication 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. Email: saft@thomsonreuters.com --

Editing by Ruth Pitchford

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