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Recent trends in household net worth

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There has been considerable interest in the economic behaviour of households over the last 10 years. This is not surprising, given that personal income and personal expenditure are equivalent to about 60% of GDP. Furthermore, a number of recent events have generated increased interest in both the economic activities and the accumulation of wealth in the personal sector.

The decline in saving has also given rise to a debate over the impact of a potential “wealth effect” on personal consumption and saving. Specifically, that declines in saving have been more than offset by gains in net worth, such that households’ financial positions have not deteriorated. This, in turn, may be supporting consumer expenditure in the economy.

Data released in the National Balance Sheet Accounts may shed some light on these and other issues. With non-financial assets and financial assets now estimated at market value, the role of wealth in the economy can now be examined. This note looks at the evolution of wealth and its components. The paper reviews the trends and fluctuations in non-financial assets, financial assets and liabilities. It then summarizes the impact of changes in assets and liabilities on net worth and ties this to the evolution of personal saving.

Financial asset growth dominated by marketable equity securities as well as pension and investment funds

Despite the fact that financial asset investment has slowed, keeping in line with a trend to weaker personal saving, growth in financial assets has outpaced that of non-financial assets over most of the last 14 years. Between the first quarter 1990 and the first quarter 2004, the nominal value of household financial assets at market value more than doubled. The contribution of financial assets to the growth of and fluctuations in household net worth has been driven by assets whose values have been largely determined by rising equity prices. These include corporate equities and investments fund units as well as the less discretionary assets, such as insurance and pension funds.

Financial asset growth stronger but more variable than non-financial assets
Chart: Financial asset growth stronger but more variable than non-financial assets

This suggests that there has been a shift in the way in which financial asset wealth has been accumulated since 1990 – with substantially more arising from capital gains than from investment flows. This has helped consumers to generally sustain strong borrowing and spending, as financial asset growth exceeded that of previous decades. However, this type of secondary saving has exposed households to a greater degree of risk than has been the case in the past, as unrealized capital gains can be reduced should stock markets decline1.

Growth in the shares category was led by mutual funds despite the sector’s declining proportion of such assets, with institutional and other investors increasingly holding investment fund units. The sharpest growth in investment units was between 1996 and 2000 and was abruptly halted by the stock market correction, largely reflecting the reliance on equity in mutual fund portfolios.

Among marketable securities held by households, the value of listed shares rose almost four and half times since 1990, largely from revaluations. Holdings of marketable shares rose sharply between 1995 and 2000, closely following the ups and downs in the stock market over time.

Insurance and pension fund assets rose at an increasing rate up until 2000. Pension fund assets were the dominating factor, fed by both a rise in contributions to such plans, as the post-war baby-boom generation approached retirement, and gains and losses on equity investments of these retirement schemes.

Interest-earning financial instruments – deposits, savings bonds and marketable debt securities – were in relative decline over most of the last 14 years, as household portfolio strategies evolved. This reflected both a preference for higher-yielding instruments, set against the long-term downward trend in interest rates since 1990, as well as the general absence of capital gains on these assets.

Investment and gains in the value of residential real estate led growth in non-financial assets

The personal sector non-financial assets account for the largest share (just over 50%) of non-financial assets in the Canadian economy. Non-financial assets – largely real estate and consumer goods – currently represent about 46% of total household assets, though this share has generally been on the decline over time, reflecting the aging of the post-war baby-boomers. Yet, between the first quarter of 1990 and the fourth quarter of 2004, the nominal value of household non-financial assets at current values almost doubled.

While there was a steady increase in both components (real estate and consumer goods), residential real estate drove growth to reach $1.6 trillion or 77% of non-financial assets by the end of the first quarter 2004. After the 1990 decline in the residential real estate market, followed by a few sluggish years, housing prices moved up throughout most of the 1990s as did housing investment2. The downward trend in borrowing costs over this period acted to stimulate housing demand.

In recent years, the housing boom has played an important role in sustaining economic activity, with housing investment growing at a torrid pace since 2001. Consistent with this level of activity was a demand-driven increase in the value of residential real estate3 which reflected the impact of a demographic younger than the baby-boom generation.

Clearly, both expenditures and capital gains in residential real estate had a significant impact on the advance in personal sector net worth over the whole of this period, in particular in recent years.

The second largest non-financial asset of households is the stock of consumer goods. Increases in the net worth of the household sector related to holdings of durable goods have been more related to expenditure flows than was the case for residential real estate. This reflects the fact that certain goods have experienced price declines in recent years. Growth in these assets since 1990 may be associated with a stimulus to personal expenditure caused by the perception of rising net worth. Notably, the recent stock market correction did not appreciably slow personal expenditure, suggesting that the wealth effect may be one-sided.

While consumer durable stocks4 grew 70% over the past 14 years, motor vehicle holdings grew 86%, shifting their share of household total consumer durables upward (from 42% in 1990 to 46% in 2003). This may be explained by the growth in motor vehicle purchases5, in part encouraged by lower prices and lower borrowing rates especially on newer types of financing6. Household and purchases of furniture and appliances account for 23% of consumer durable stocks. The recent housing boom has stimulated demand for new household goods.

Household sector debt outpaced income but not wealth

Over the past 14 years, there has been a significant run-up in household debt, coinciding with the decline in the saving rate. This is a continuation of a long-term trend in demand for housing and goods and corresponding increased household indebtedness that has reflected demographic demand as well as more relaxed attitudes towards debt on the part of both lenders and borrowers.

In addition, the general trend of falling interest rates since the double digit rate barrier was broken in December 1990, has encouraged the demand for funds. Over the past 14 years, the ratio of interest payments to personal disposable income has generally fallen or remained stable, so that debt burden has not increased.

Household debt has grown more quickly than income over the last 14 years, but has not kept pace with household net worth over most of this period. This suggests that as long as net worth grows faster than liabilities, an increasing level of household debt is sustainable, providing the ability of households to service this debt remains stable. However, increased borrowing with the expectation of increased asset prices contains an element of uncertainty. Historical incidences of falling asset prices create the possibility that household net worth can decline.

Leverage in the 1990s declined largely due to capital gains on both financial investments and non-financial assets. However, since 2000, household debt to net worth has generally increased up reflecting the impact of stock market related losses. Nevertheless, mortgage debt relative to residential real estate has declined in recent years, especially given the sharp price increases evident in the housing market.

Household leverage fluctuates with asset values
Chart: Household leverage fluctuates with asset values

Consumer credit has grown more rapidly than mortgage debt over the last 14 years, in line with the strength of personal expenditures. Typically, consumer debt carries higher borrowing costs than mortgage debt, but much of this growth has been related to the increased use of lines of credit7, which have lower interest rates than other forms of consumer borrowing.

Household balance sheets still strong

For some time, given the strength in expenditures and the related run-up in liabilities, the health of personal sector finances has been in question. However, new evidence from the National Balance Sheet Accounts has indicated that the household sector financial position is relatively strong, despite the downward trend in saving and the corresponding run-up in debt coupled with lower investment flows in financial assets.

The evolution of the household sector balance sheet has gone some distance in explaining the long-term decline in saving and the saving rate, as traditional saving has been largely displaced by appreciation of assets. Saving accounted for a mere 12% of net worth changes on average since 1995. This suggests that a wealth effect may be present in personal consumption and saving, and may have had a prominent role in sustaining household demand for housing and consumer goods and services.

Net worth changes driven by gains/losses on assets and not saving
Chart: Net worth changes driven by gains/losses on assets and not saving

Nevertheless, the reliance on asset appreciation-based saving has left the personal sector somewhat more sensitive to swings in the residential real estate market and to fluctuations in the stock markets than was the case in the past. For example, holdings of equity drove growth in portfolio value but exposed households to capital loss risk. Over the medium to longer term it is not clear how increased market exposure will impact on the adequacy of household funds for retirement. This factor, combined with potential vulnerabilities with respect to interest rate swings on an increased debt load, has provided a qualifier to the general assessment of the personal sector balance sheet.

All of this has cast a somewhat different light on the significance of the personal saving rate, in favour of other indicators – in particular, a broader measure such as the change in household net worth.

1 The financial assets held in a household’s investment portfolio can be distinguished by the risk associated with each asset type, with deposits being low risk placements and marketable securities being high risk. Assets that are based on funds pooled and placed under professional management (e.g., pension funds and investment funds) have moderate (indirect) risk associated with them.
2 Changes in the value of real estate have two determinants: the flow of investment in housing and the re-valuation of the existing housing stock. In addition to providing use value to the homeowner, real estate has been traditionally viewed as a reliable investment whose value will likely grow over time.
3 This is reflected in both the reproducible cost of the structures as well as in the gains in the value of the underlying land.
4 In the National Balance Sheet Accounts consumer durable stocks are an asset, while (following international national accounts’ convention) in the Income and Expenditure Accounts consumer spending is current spending. This difference is accounted for as a conceptual change.
5 Canadian System of National Accounts’ convention is to treat leased automobiles as final sales to consumers.
6 For example home equity lines of credit and leases.
7 A significant portion of lines of credit is home equity based and is used to acquire assets (including home furnishings) and to undertake home renovation, as well as for debt consolidation.