Household Balance Sheet

[brainclamp]

The accounting equation.

Owner Equity = Assets - Liabilties

The balance sheet equation.

Assets - (Owner Equity + Liabilities) = 0

Owner Equity/Net worth can be defined as:

Owner Equity: Income + Savings + Shareholdings of Assets

Recently, the BOE's chief economist has stated that although the level of household debt (and debt spending) has risen sharply, the rising value of household assets has more than offset record debt levels.

Does it really matter if a household has debt of £50,000 if thier Assets have increased by £120k to be worth £250,000 and thier Equity has increased to keep pace.

To take an extreme case - Does it matter if household debt is £10billion, if household assets also rise to keep pace?

" Bean seemed less bothered by the record rise in consumer debt. Data on Thursday is expected to show outstanding consumer debt passed the trillion-pound mark in June.

"While gross household debt has risen from about 90 percent of annual personal disposable income in 1998 to about 120 percent today, the household savings rate has not been unusually low," Bean said.

While some households may have difficulties in paying back their debts, Bean said they represented only a small fraction of consumer expenditure and did not represent a threat to the overall macroeconomic outlook."

[Randall Herbert]

"Does it really matter if a household has debt of £50,000 if their Assets have increased by £120k to be worth £250,000 and their Equity has increased to keep pace?"

I'd suggest that if their inflated bubble asset is the only thing underpinning the balance sheet, that would be cause for great concern, especially if sizeable MEW has been released on the basis that the gain is a permanent one (i.e. new paradigm etc. )

After all, the huge wads of money floating around the economy with gay abandon over the past few years was hardly underpinned by something substantial like perhaps a positive balance of trade? More like Joe public borrowing like crazy after being conned by 'Crash' Gordon Brown into putting off the inevitable recession for a couple of years.

Talking of which, the new Paradigmers have run for cover of late?

Is this the new Stagadigm period instead?

[brainclamp]

http://www.findaproperty.com/cgi-bin/story.pl?storyid=3718

"British households are well in control of their finances, despite average debts amounting to £32,000.

This may look like an alarming figure, but according to Egg soaring incomes, an overall reduction in the cost of borrowing, and an increase in the value of household assets mean that debt is far more affordable than in the dark days of the early 90s.

In 1988, says the bank, the average household had an income of £18,040 and debts of £15,039 against assets worth £91,315. Since then our indebtedness has soared by 118%, to £32,815, but so too has our personal wealth.

In 2002 the average household income is £32,759, an increase of 82%, while the value of household assets has soared to £220,227, an increase of 141%.

The average cost of servicing non-mortgage debt - credit cards, hire purchase, and personal loans - is currently £749 per household per year, making debt highly affordable by historic standards, says the report.

When mortgage payments are included, total interest payments per household per year are currently £2,239 on average and have remained steady over the past few years at around 7% of household income. This is down considerably from their peak of 11.1% of household income in 1990.

Egg's director of banking and insurance, Andy Deller, said: "When we strip out property we see non-mortgage debt (such as credit cards) is relatively stable and well below the danger levels witnessed in the 90s. The cheaper cost of borrowing and a near doubling of incomes have meant a steep fall in borrowing costs as a proportion of incomes since 1990."

Who's Borrowing?

The research also found that the people taking on the most debt are middle aged, living in the South East of England and on higher than average incomes.

Many were borrowing to invest in property and other assets. "A lot of the growth in credit is coming from people who are relatively affluent and are borrowing to amass assets," said Deller.

While poorer people earning the lowest incomes in society tended to spend the greatest percentage of their income on servicing their debts, high earners are also spending a large proportion of their income on debt payments.

The most conservative borrowers identified in the study were those in the second rung from the bottom, or those earning slightly below average wages. Deller said these people may be taking a more cautious approach to debt because of fears they wouldn't be able to afford to bail themselves out of a problem. "

I posted the balancesheet equations because they are central to a understanding of debt levels.

Clearly, the central bank - rather Mr Bean its chief economist says everything is honky dory and debt is not a worry.

This has important implications - it implies houseprices will not fall in a significant way in nominal terms, enough to create problems for the household balancesheet. The basic indication is a fall nominal terms, but more in real terms as earnings catch up.

The peak of the last boom

In 1988, says the bank, the average household had an income of £18,040 and debts of £15,039 against assets worth £91,315. Since then our indebtedness has soared by 118%, to £32,815, but so too has our personal wealth.[/b]

1988 Equity = £91315 - £15039 = £76276 + £18040 = £94516

1988 Household Debt to Equity = 16%

Then, we had historically low interest rates and high employment. Its important to realise that in 1988 interest rates were at artifical lows, and as employment reached historic highs, the central bank policy was locked into low rates which resulted in a sudden rise in inflation and spending which needed interest rates to double to quell. This had a immediate effect on spending, thus employment and thus on the economy.

The greater picture was that in economic terms people had been spending above thier REAL incomes, and not saving. Interest rates were high only for a short spell and then were lowered. Household Asset values fell until savings were slowly rebuilt to replace the lost equity which took seven years.

2002 situation

In 2002 the average household income is £32,759, an increase of 82%, while the value of household assets has soared to £220,227, an increase of 141%.

2002 Household Equity = £32,759 + £220,227 - £32,000 = £220986

2002 Household Debt to Equity = 14.5%

Employment is at historic highs and Interest rates at historic lows. People are spending this equity which has kept the economy afloat. The BOE now reckons that it has engineered a soft landing by raising interest rates at the right time and now expects a period of leveling off.

[brainclamp]

[brainclamp]

The savings ratio indicates a similar situation to 1988. Low interest rates acted as a disincentive to save and instead people were spending thier incomes and levering on debt.

People were forced to save from earnings to repair thier balance sheets after the artifical boom ended. Do you really think the BOE has engineered Browns dream of a perfect leveling off of full employment and low interest rates?

[eek]

Brainclamp,

And also unemployment was low so there was little need to save.

If you look at the peak saving times, there is little there that corrolates with house prices and an awful lot that corrolates to unemployment rates.

[brainclamp]

That explains the spike during the recession in 2001.

[RJG18]

You can't determine the true value of an asset (over ANY period of time) simply as "the price you paid for it". Otherwise you could fully justify borrowing ANY amount of money to buy ANYTHING at ANY price, and always show a Debt to Assets ration of 1:1.

For example, if you borrow £50,000 to buy some "magic beans" from me for £50,000, then you could always argue that your economic health was very good, as while you had £50,000 of debt you also held £50,000 of assets.

The difference is that asset prices can (and always have done in the past) go up as well as down. When you overpay for an asset in a boom/bubble then when the price falls your ratio of Debt to Assets will rise alarmingly.

Will all lemmings please swallow their "Asset-to-Debt Ratio" placebo pill, then stop asking questions and go back to watching Linda Barker laying laiminate flooring on the tele (ooh, ooh, you could do that too). ALL IS WELL!

[brainclamp]

http://www.sundayherald.com/44011The UK currently has one of the lowest savings ratios among developed countries – significantly lower than elsewhere in Europe – and the latest figures available show it falling again.

It had begun to creep up from the dismal 5% ratio of the 1980s, reaching 6.4% at the end of last year, before collapsing again to 6.1%. That said, inflows into banks and building societies have held up strongly, according to Robinson, as investors opt for safety over the stock market.

He argues: “Academics have carried out a lot of research into what drives the savings ratio, with various conclusions. However, the constant which does appear time and again is the house price index. “When that is rising strongly, savings remain fairly stable, but if house prices are falling then savings begin to rise.”

According to MoneyFacts, the savers’ bible, the best rates continue to be offered over the internet, with postal and phone accounts following behind. Branch-based accounts, which are more expensive to run but offer greater convenience, tend to come third. However, there are still many good accounts on offer through the branches.

Introductory bonuses are also popular with customers – however, savers must remember that when the bonus period is over the rate will fall, and they may need to review the account again.

Skipton Building Society increases its rates by an average 0.25% from August 31. Its Branch Access account will pay 5.50%, including 1% bonus for the first three months, on a minimum £500. Its Base Rate Tracker rises to 5%.

Scottish Widows also pays an introductory bonus of 0.75% for the first six months. Its new rate on its instant access is 5.11%, including the bonus, on minimum £100 deposits.

Widows spokesman Murdo McHardy agrees there has been no strong upswing in deposits, but added: “People are moving their money around much more than ever before.”

[eek]

That explains the spike during the recession in 2001.

A rise from 5.5% to 7% is hardly a spike.

Also I know of a large number of people who had a very grotty 2001-2. While most of the country may not have noticed the IT industry went through a serious recession (especially if you are / were a contractor).

[brainclamp]

RJ108 - Oh but that is EXACTLY what the BOE chief economist is saying - thats why I posted the equation and figures that show debt is not a problem.

Also read this

http://www.businessreport.co.za/index.php?...ticleId=2179272

"the bank brought out Charles Bean, its chief economist, to deliver a learned lecture on why debt is not nearly as scary as once thought.

Bean's message? Don't worry, enjoy summer, and use the plastic. So long as assets matched debts, the debts could be safely managed.

But that view is likely to seem dangerously complacent, considering that the bank on Thursday raised interest rates a quarter percentage point to 4.75 percent.

According to the Organisation for Economic Co-operation and Development, UK household debt comes to 129 percent of disposable income, compared with 112 percent in the US and Germany. Only Japan is higher, at 140 percent.

In Britain the thirst for credit looks unshakable. Credit card loans and financing through stores in June climbed £2.1 billion, the biggest jump since October 2002, according to the bank.

Rising interest rates have so far done nothing to slow that.

Debt is soaring worldwide for two reasons. One is low interest rates. The other reflects the way manufacturing has shifted to developing nations. Most wealthy economies are now consumption rather than production led.

If central bankers want to raise growth, and most do, they have to encourage consumption. That means encouraging debt.

Bean thinks that's fine.

"The household debt build-up has been primarily associated with asset accumulation rather than borrowing to finance current consumption," he lectured to the Institute of Economic Affairs.

In practice, most of those loans have been taken out to buy houses that are escalating in price. That, apparently, makes it okay.

[brainclamp]

For example, if you borrow £50,000 to buy some "magic beans" from me for £50,000, then you could always argue that your economic health was very good, as while you had £50,000 of debt you also held £50,000 of assets.

We have our own very special Mr Bean, who would counter that the debt is not being used to finance current consumption, but to buy assets like houses. So thats ok...

[van hoogstraten]

Do the BOE seriously believe that morgage equity withdrawal is to purchase home improvements and not to fund current consumption, or to pay off short term debts by replacing them with 25 year mortgage debt.

That the UK consumer (who is representative of the UK economy which, after all, is based on people going to the shops to buy imported goods with borrowed money) - continues to live beyond his means depends on the greater fool theory and the willingness of his creditors to allow him to get ever deeper in to debt. Once he maxes out on his credit, the economy will come to a juddering halt, and that is before one penny of debt is actually repaid.

[RichM]

Sorry have I missed something?

The BoE thinks we have a trillion pounds of debt but 3 trillion of assets, ergo we are fine.

But hang on, the valuation of those "assets" could change very quickly, while 1 trillion pounds of debt will go nowhere at all in a low inflation economy.

I don't get it - surely I don't understand, it can't be that the BoE is spouting rubbish, is it?

[RJG18]

And we should point out that 3 Trillion of Assets (mainly property) is only worth 3 Trillion if you can find someone to seel them to at that price.

Having higher Assets than debt is meant to be relatively save because you can liquidise your assets to clear the debt and remain safe. For example, say you have a £6000 car and a £2000 debt. If you get into difficulty with that debt, you can sell the car for £6000, clear the £2000 debt with the money, and still have enough to buy a slightly cheaper £4000 car if you so wish.

However, where assets prices have been funded by their own price growth (i.e. with property) there is no way to sell the asset to clear the total debt. I.e. if we ALL have trouble servicing our debts then we can't simply sell our £3 Trillion of property, pay off our £1 Trillion of debt and walk away safe with £2 Trillion. this is because the current £3 Trillion of property value is funded by it's own growth, and does not actually hold that fundamental value. The only way "someone" could buy the £3 Trillion of property from us to clear our £1 Trillion debt would be to take out more debt pay for the £3 Trillion of property. I.e.

For us to sell our £3 Trillion of property to each-other to clear our debt, we would all need to borrow a further £3 Trillion to buy eachothers property off eachother.

Net result would be:

Current Debt = £1tn, Current Property Assets = £3tn,

-- Borrow a further £3 Trillion --

Current position now Debt = £4tn, assets = £3tn

-- Sell property to "eachother" for £3tn (paying with the borrowed money) ---

-- Use proceeds to clear the original £1tn of debt --

End position: Debt = £3tn, Assets = £3tn.

There is no way that nationally our £3tn of property can safely secure our £1tn of borrowing on an over-valued asset like this. Any attempt to clear the debt buy liquidising the assets can only have the net result of increasing the total debt (it's what you get when the current "value" of an asset has been reached by self-fuelling price growth, to outstrip it's fundamental value).

[brainclamp]

Sorry have I missed something?

The BoE thinks we have a trillion pounds of debt but 3 trillion of assets, ergo we are fine.

But hang on, the valuation of those "assets" could change very quickly, while 1 trillion pounds of debt will go nowhere at all in a low inflation economy.

I don't get it - surely I don't understand, it can't be that the BoE is spouting rubbish, is it?

"However, a mixture of wishful thinking and mistaking a long cyclical upswing from a deep

recession for an increase in the underlying trend rate of productivity growth lulled policy makers

and consumers into believing that the robust non-inflationary growth experienced during 1983-8

would continue into the future. This optimistic atmosphere was neatly encapsulated in a 1988

edition of Time magazine with the cover “Britain is Back!” and containing a lead article

eulogizing Thatcher’s Britain. The robust growth led to burgeoning public sector surpluses,

which the government then chose in part to remit as lower taxes, offsetting the automatic

stabilisers. It also kept interest rates low, in part to prevent the exchange rate appreciating during

the 1986-7 period when unofficial policy was to shadow the DM, and in part because of the

political sensitivity of high interest rates with most mortgage debt being at flexible rates.

Moreover, households faced with rapidly growing disposable incomes and with much greater

access to easy credit as a result of reforms to the financial sector were spending as if there were

no tomorrow. These optimistic expectations fuelled an extraordinary boom in house prices,

increasing households collateral and permitting further borrowing for current consumption (socalled

“housing equity withdrawal”). The counterpart to this was a marked deterioration in the

current account of the balance of payments. Eventually this domestically-driven boom (the “Lawson Boom” after Chancellor Lawson) ran

into the buffers as the supply limitations of the UK economy (low level of workforce skills, etc)

once again became apparent and inflation started accelerating. Monetary policy was then

tightened, first by talking up the exchange rate through dropping hints about future entry into the

Exchange Rate Mechanism, and then ultimately locking it in 1990 at a rate that was widely seen

as at least 10% overvalued. This, of course, occurred at exactly the moment European interest

rates started to rise as the Bundesbank fought to limit the inflationary pressures associated with

German re-unification. At the same time as policy was tightened, households cut back severely

on their spending as they realised that their income expectations had been overly-optimistic and

tried to reduce their indebtedness. The result was that boom turned to bust almost overnight as

the economy slid into a recession as deep as that of 1980-81.

This experience is salutary as it points to the dangers when policy makers and private agents erroneously mistake a once-off increase in the level of national or personal incomes, for a

permanent increase in its growth rate. The UK experience suggests that Australian policy makers

and households would be unwise to project the recent high rates of productivity growth into the

future." Mr Charles Bean

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The above is from Mr Bean. So from Beans viewpoint - its ok that houseprices are rising as this is merely redistribution of wealth as the current account deficit is not affected?

[Guest Retired Pensioner]

Excellant thread

[brainclamp]

Summary of Mr Beans position.

(1) Rising Debt is not a problem - as its matched by greater rises in assets in the household balance sheet.

(2) Most of the rise in debt is BTL - This is a 'GOOD THING' . (As far as Mr Bean and the BOE is concerned) This is very important as it is not used to finance current consumption, which would serverly affect the balance of payments.

"permitting further borrowing for current consumption (socalled

“housing equity withdrawal”). The counterpart to this was a marked deterioration in the current account of the balance of payments" In Mr Beans words.

(3) When Demand runs into Supply constraints due to high levels of employment, Inflation will start. Interest rates have to create a 'buffer of spare capacity'.

"supply limitations of the UK economy (low level of workforce skills, etc)

once again became apparent and inflation started"..."At the same time as policy was tightened, households cut back severely on their spending as they realised that their income expectations had been overly-optimistic and tried to reduce their indebtedness."

(4) Automatic Stabilisers are now fully present which were not in place during the 1988 Lawson boom. Basically deficit fueled government spending overcoming deflation while taxes remain the same during a downturn, and a cut bank in government spending overcoming inflation when in a upturn with taxes replenishing the deficit.

(5) Mr Bean wants a similar situation to the 1950s housing correction. Rising real post war incomes made up for high houseprices.

[George Mainwaring]

The BoE's job is to steer the economy on a steady course. Everyone panicking about the 3T debt and stopping spending would cause a recession. So they've spun it for now while applying the brakes gently.