WASHINGTON (MarketWatch) -- Hit by a double whammy of declining home prices and a falling stock market, U.S. households saw their net worth fall by $11.2 trillion, or 18%, to $51.5 trillion at the end of 2008, wiping out four years of gains, the Federal Reserve reported Thursday.
In the fourth quarter alone, household net worth fell by $5.1 trillion, a record 31% annualized decline. Consumers lost $937 billion on the value of their real estate. Their direct holdings of corporate equity dropped by $1.68 trillion, while holdings in pension and life insurance reserve dropped by $1.46 trillion. Mutual-fund holdings fell by $730 billion.
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Net worth has fallen for six straight quarters since peaking at $64.4 trillion in the second quarter of 2007. Net worth -- defined as assets minus liabilities -- is down 20% from the peak.
The decline in wealth was accompanied by a sharp pullback in consumer spending at the end of the year. According to Commerce Department data, real consumer spending fell at a 4.1% annual rate in the final six months of 2008, the sharpest decline since 1980. Economists figure consumers will spend about 5 cents out of each additional dollar of wealth, or cut spending by about 5 cents for every dollar lost.
"Consumers have turned a lot more cautious and are saving more," said Richard Berner, chief economist for Morgan Stanley. In the longer term, Berner sees a "sea change in consumer behavior" that will bring the personal savings rate to 7% or 8% within the next few years as consumers begin to understand that quick and easy increases in wealth aren't likely.
"Households are being forced to rely less on rising asset prices and more on their paycheck to fund everyday living expenses," wrote Drew Matus, an economist for Bank of America/Merrill Lynch. "In other words, frugality is coming back into fashion."
The decline in net worth raises the risks of deflation, Matus said. He said money supply growth turned negative in the fourth quarter, based on more complete information about the shadow banking system.
Lost decade
At the end of the year, households owned $9.9 trillion in equity shares outside of pension plans, less than the $11.3 trillion they owned in 1998.
At the end of 2008, assets fell by $11.3 trillion to $65.7 trillion. Liabilities fell $87 billion to $14.2 trillion.
Home owners' equity in their houses fell to a record low 43%. "It's an old lesson: Asset values can fall quickly, but debt lingers!" wrote Bill McBride on his blog, Calculated Risk.
At the same time their assets were falling, households were taking on less debt, deleveraging their balance sheets after five years of double-digit growth in debt.
In the fourth quarter, households paid off more debt than they took on for the first time since at least 1952, when the Fed began reporting the information in its quarterly Flow of Funds report. Household debts fell at a 2% annual rate in the quarter, including a 1.6% decline in mortgage debt and a 3.2% decline in consumer credit, including credit cards and auto loans.
For all of 2008, household debt rose just 0.4%. Since the early 1950s, debt had never risen less than 5% in a year.
Businesses also took on less debt. Total debt grew 4.8% in the corporate sector after a 13.4% gain in 2007. In the fourth quarter, corporate debt increased at a 2.2% annualized rate, the slowest since early 2004.
The federal government made up for the deleveraging by families and businesses, however. Federal debt increased 24% in 2008 and rose at 37% annual rate in the fourth quarter.
Total nonfinancial debt -- individuals, businesses and government -- rose 5.8% in 2008 and increased at a 6.3% pace in the fourth quarter. It was the slowest annual increase in debt since 2000.
Rex Nutting is Washington bureau chief of MarketWatch.
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