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Households' balance sheet repair continues (2)




According to the Federal Reserve's calculations, the net worth of U.S. households as of last December had increased by $5.7 trillion (up 11.6%) from the low of last March. The gains came from a combination of higher equity and bond prices and reduced debt that overwhelmed declining real estate values. This reflects a healthy realignment of households' balance sheets (lower debt ratios, less reliance on real estate), as well as healthy improvement overall. However, it will take a few more years before households have recovered their peak net worth.

I note that the ratio of household's tangible asset holdings to total assets is now 33.7%, which is below the average of this ratio (36.6%) since records began to be kept in 1950 (see chart below). To me, this suggests that the correction in real estate prices has largely run its course. You might say that real estate is now somewhat "cheap" relative to financial assets. Think of the "tangible asset ratio" as a measure of how enthusiastic households are to own real estate instead of other sources of wealth such as stocks and bonds. Also note that the public's willingness to pay up for real estate is roughly correlated with underlying inflation, as the chart suggests. Tangible assets are a natural inflation hedge, so this makes a lot of sense. If inflation has bottomed out this past year and begins to rise in the years to come, then we could expect tangible asset prices to recover.

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