Fed Data: Are We Richer Than We Thought?

The latest numbers from the Fed show that debt has been falling and home values have been rising. And that won’t stop soon.

Why was President Obama doing so well in the polls while the economy was in the toilet? Versions of this question were asked over and over by pundits through the summer and September, as Obama maintained a steady lead. He would, of course, go on to win, seemingly in face of a weak economy. And to be sure, growth is subpar and could dive near zero by the end of this year. But when it comes to the personal finances of households, Federal Reserve data show that Americans were doing a lot better this fall than we thought.

Americans are paying off debt on their homes while taking on a little more debt to make purchases. Meanwhile, the value of their assets—chiefly homes and stocks—has been rising. And that makes for an excellent combination.

In the third quarter, according to the Fed’s latest “Flow of Funds” report, debt held by households fell 2 percent at an annual rate, and home-mortgage debt declined 3 percent, continuing a trend that started in 2008. Consumer credit, on the other hand, rose for the eighth straight quarter, this time at an annual rate of 4.5 percent. All told, households have $12.9 trillion in debt, nonbank businesses have $12.1 trillion, and state, local, and federal government has $14.3 trillion in debt. The hidden riches, such as they are, came in household net worth, which is household assets minus their debts. It stood at $64.8 trillion, a $1.7 trillion increase from the second quarter. Of that increase, $800 billion came from rising stock and mutual fund values, and $370 billion came from higher real-estate prices.

This time around, however, the rise in housing isn’t being accompanied by a rise in mortgage debt. That’s because many underwater homeowners are not able to sell their homes or refinance. Instead, they are patiently making their mortgage payments and getting closer to positive equity in their homes. Meanwhile, mortgage modifications and foreclosures continue to lop off mortgage debt. At the same time, home values are rising across the board and are rising especially sharply in some of the areas most affected by the housing crash. Finally, a huge portion of new mortgages are actually refinancings. For example, at Wells Fargo, the biggest mortgage servicer in the country, 72 percent of mortgages in the third quarter were refinancings. Also, Home Affordable Refinance Program, the government’s initiative to assist distressed homeowners whose homes are worth less than the outstanding mortgage, has exploded. The program has completed 709,000 refinances through September; it has done 1.7 million total since its inception in April 2009. Of those completed this year, 142,000 have been for homeowners whose mortgage is worth 25 percent more than the value of their home.

According to data from Freddie Mac, 83 percent of all refinances were either at the same outstanding loan amount or actually lowered the balance, meaning that those homeowners’ overall mortgage debt either stayed the same or went down. This is a remarkable contrast from the boom years, when “cash out” refinances, which increase outstanding debt, were common: in 2006, over 80 percent of all refinances increased the amount of outstanding debt by 5 percent or more. The latest Fed data show that there is some $12.9 trillion of household debt and $10 trillion of home-mortgage debt.

That fact that debt reduction came chiefly from lower mortgage debt can help explain why the economy felt more buoyant than top-line numbers on GDP growth and job growth indicated. That’s because of the “wealth effect”— i.e. the relationship between higher household asset values and higher consumption. The most comprehensive academic research on the wealth effect shows that the effect is far higher when the increased wealth is in higher home values as opposed to stocks.

The recovery, such as it is, may only be showing up below the surface and in some data. But as home and stock prices rise (and there is little reason to think homes will stop appreciating soon), the recovery will become more obvious, and we won’t have to look back at the data to find it.