The Precarious State of Household Finances

The International Monetary Fund is warning that many households in the US and UK are dangerously over-extended:

The world's chief financial watchdog said households in countries such as the UK and US were exposed to asset prices such as housing that were being used as collateral for their debts.

"These developments increasingly expose the household sector to the performance of asset markets," it said in its biannual review of financial stability. "Most likely, substantial asset price declines would undermine consumer confidence and reduce personal consumption."

In another report on this warning from the IMF, focusing on personal bankruptcies in the UK:

The highly-respected economic watchdog sounded the alarm over the recent record increase in personal bankruptcies.

They rose by 37% to 11,195 between April and June compared to the same period last year, according to government figures.

The IMF's experts said that if the increase in bankruptcies continued, it would be a serious threat to the UK economy.

... The unsecured debt mountain - which includes credit card borrowing, loans and overdrafts - has soared to £190billion, according to the Bank of England. This translates to £3,200 for every person in Britain, including children.

This outcome could have serious ramifications if it occurs in the US and leads to depressed aggregate demand. Calculated Risk says:

In my view, whether the US economy has reached a "tipping point" depends on housing. Housing is the key. If the boom ends, mortgage extraction will end, and the US consumer will be forced to live within their means. That isn't necessarily "dire" and I'm not wearing a sign proclaiming the "End of the World as We Know It" - but I do think these are interesting economic times. Achieving a soft landing, expecially without fiscal and public policy leadership, seems impossible.

Here are some of the IMF data for the UK:

At the end of 2004, household debt represented 102 per cent of GDP, and 150 per cent of annual household income, pointing to some potential vulnerability in household balance sheets," it said. Total household debt hit the £1 trillion mark this year, although the pace of increase has slowed since then.

The slowdown has been most dramatic in the housing market. The annual rate of house price inflation fell to just 2.5 per cent last month, compared with 21.3 per cent in the same period a year earlier. Mortgage approvals in May 2005 were down 24 per cent from a year ago, while mortgage equity withdrawal - raising money against the value of a home - has fallen from £17.5bn to £6.5bn between the end of 2003 and the start of this year.

Add the following from George Trefgarne to the above doom and gloom stories:

I am going to make a rash but depressing prediction: 2006 is going to be the toughest year for the economy for more than a decade.

... in the face of new evidence, I have done the only rational thing possible: changed my mind. The British economic tiger is suddenly looking rather mangy and won't do tricks any more when circus master Brown cracks his whip.

The negative signs do not seem so powerful for the US economy. Nevertheless, it might be time to go liquid [scotch or money markets -- take your pick].

[Thanks to SC and MA for the pointers]