Finances Off, Consumers May Trim Spending
Jun 16 6:31pm ET
By Daniel Sternoff
NEW YORK (Reuters) - Keeping the world's largest economy from tipping into recession is no light task, and American consumers have so far shouldered that burden with backs unbowed.
But dangerous cracks are starting to appear in household balance sheets, and analysts fear consumers may bend as they cope with a converging crunch of falling wealth, rising debt and slower income growth.
A detailed Federal Reserve report card on the health of U.S. households issued last week showed American finances are looking increasingly stretched.
More U.S. household wealth evaporated in the first quarter of 2001 than in all of 2000 -- which was the first year in half a century in which American net worth declined, according to the Fed's quarterly flow of funds report.
The report also showed the ratio of outstanding consumer debt to household income hit more than 100 percent, its highest since World War 2, and up from 88 percent in 1995.
"Consumer spending will maintain a more subdued pace than what we have seen in the past. There is still a risk of outright retrenchment in coming months," said Richard Berner, chief U.S. economist at Morgan Stanley in New York.
Undaunted by rising layoffs, a steep industrial slump and a bleak corporate earnings and investment outlook, consumer spending on cars, homes and goods has accounted for nearly all of the economy's meager growth in the past few quarters.
The government on Wednesday reported retail sales rose by 0.1 percent in May after a surprisingly robust 1.4 percent gain in April, pointing to a slightly faster pace of consumption growth in the second quarter compared with the prior six months.
Optimists believe a bonanza of tax rebates and the Fed's deep interest rate cuts this year will ensure cash registers keep ringing at a modest pace until corporate America sweats through a sour business cycle.
But those who viewed the no-holds-barred spending and borrowing habits of the late 1990s as unsustainable excesses believe a bout of national belt-tightening could keep the overall economy sluggish for some time to come.
THE DISAPPEARING $3.4 TRILLION
High on the list of concerns is the staggering $3.4 trillion in wealth that went up in smoke as falling stock markets reached their nadir in the first quarter, far outstripping rising real estate values and fixed-income returns.
"The decline marks the largest wealth loss ever recorded over a four-quarter period," said William Dudley, chief U.S. economist at Goldman Sachs, who this week crunched the numbers in the massive flow of funds accounts.
Even with the stock market's rebound from its late-March lows, Dudley said the ratio of household net worth to disposable income is still down by around 60 percent in one year.
The Fed has warned that just as soaring stock prices fueled a consumer spending boom in the last 1990s, eroding equity wealth will inevitably restrain spending on the way down.
But just how much is a matter of great debate among economists. Fed Chairman Alan Greenspan has said rising home values makes it difficult to gauge how severely falling stock prices will impact spending.
Optimists, such as Merrill Lynch senior economist Gerald Cohen, say last year's declines in net worth have only dented an unprecedented rise in wealth in the last decade.
"We are still at exceptionally high levels of assets to income," Cohen said, noting that household wealth stood at 550.6 percent of incomes in the first quarter, down from 633.2 percent a year ago, but still above 476.5 percent in 1995.
But that may be cold comfort for those who have to adjust dreams of bigger homes or early retirements to a new reality.
DEBT CRUNCH
The Fed's flow of funds report showed consumer debt was lodged at 101 percent of incomes in the first quarter -- the highest in half a century. Household debt rose 8.9 percent from the first quarter of 2000, while incomes rose only 4.6 percent.
"The economy is growing at 1 percent and consumer debt is growing at nine percent. That's alarming," said Jane D'Arista, program director at the Financial Markets Center, a private research group.
She said consumers, particularly low- to middle-income earners who missed out on the tide of rising home values and stock portfolios, may discover that their incomes cannot keep pace with their debt service burden in a slowing economy.
"I expect to see real wages grow at a much slower pace, if not actually stall, and see further labor market weakness," said Morgan Stanley's Berner.
Rating agencies say credit card delinquencies are on the rise and bank write-offs of bad loans are at four-year highs.
A bout of financial prudence should see consumers gradually ratchet up their rate of savings, which Goldman's Dudley said is currently some 3.5 percentage points below his estimate of a proper historical balance between earnings and spending.
"We remain concerned that persistent upward pressure on saving will keep consumption relatively weak," Dudley said.
He said stock prices would have to rise about 30 percent from current levels -- much higher than most equity strategists are forecasting given weak profits projections by major firms -- to offset the drag on consumption as savings increase.
Morgan Stanley's Berner said he did not believe consumer spending would contract sharply -- "and you are talking to the guy who has a recession forecast" -- but said anemic spending growth would keep the economy from returning to its former vigor for several quarters to come.
"Even though rebate checks will hit their wallets and the Fed has gone to great lengths to make it easier to borrow, I see very sluggish spending growth," he said.
"We are not talking about a disaster, but the balance is a delicate one," he said.
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