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Household balance sheets continue to improve

The latest data for this chart came out a few weeks ago, but it's worth highlighting nonetheless. U.S. households' net worth rose by $3.2 trillion last year, thanks mostly to a similar rise in total financial assets. The value of real estate holdings dropped by only $0.5 trillion, while debt fell by $0.1 trillion. Real estate values are now back to the levels of 2003, which is consistent with the decline in the Case Shiller home price index. Financial assets are only $3 trillion shy of their high-water mark set in late 2007.

As with the data in yesterday's posting about household debt burdens, we see that there has been a significant adjustment in relative prices (equities, bonds, and cash holdings are up, while real estate is down) and a significant improvement in households' financial health. Debt burdens are back down to levels the economy has been comfortable with before, and net worth is rising because the economy is growing, households are saving, and corporate profits are strong.

The biggest problem remaining is the substantial decline in homeowner's equity as a percentage of real estate holdings, which currently stands at 38.5%, as compared to 56.5% at the peak of the housing boom in 2006. Lots of folks have lost their homes and many are painfully underwater with their mortgages. But this is a problem that can go away with time: incomes are rising, mortgages can be and have been refinanced at historically low rates, equity rises as debt is paid down, and a stronger economy and easy money can lift home prices in the years to come. Even if more folks default, this does not destroy homes, it merely results in a redistribution of cash flows; some households will be liberated of their mortgage payments, while others will receive less than they had expected. This is not a pleasant prospect, to be sure, but it likely will encourage at least some to work harder.

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