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YOU DECIDE: Is a big financial shift coming?

April 03, 2009

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or

Dr. Mike Walden
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Every recession creates costs and losses. Jobs are cut, incomes are reduced, and stock values drop. But something more has happened during the present recession - something that many experts think will cause a major shift in our personal finances.

The devastating aspect of this recession has been the tremendous loss in household wealth. Just released numbers from the Federal Reserve show that through the end of 2008, households lost $13 trillion in wealth, or 20 percent of the wealth they had at the beginning of the recession.

No recent recession comes even close to this wreckage. During the last recession of 2001, household wealth fell a mere 0.5 percent. In the 1990-91 recession household wealth actually rose 4 percent. The closest wealth plunge came in the 1973-75 recession, when households saw 4 percent of their net assets evaporate.

The key reason for today's situation is that both twin pillars of our wealth - stocks and homes - have suffered during the current downturn. Again, it's not unusual for stocks to fall when the economy is shaky. It's the unprecedented drop in real estate - mainly fueled by lower housing prices - that is unusual.

Households have long counted on their homes as a safe investment that increased in value over time. The experience of the last two years, with housing prices and values declining in most markets, has shaken this belief to its foundation.

This is the reason many economists and financial experts say the recession of 2007 - 2009 will be a turning point in personal financial behavior. Until now, many households were living beyond their means by increasing their borrowing at rates much faster than their income. Now they're suffering the consequences.

However, before we cast too much blame, there was a very good reason for the borrowing spree. While households' borrowing was increasing faster than their income, the value of their assets was increasing even more. For example, from 1997 to 2007, household debt jumped 150 percent, twice as fast as household income. But the value of household assets rose so much that household wealth (the difference between the value of assets and the value of debt) still doubled.

In other words, households believed they could borrow more because what they owned was keeping ahead of what they owed.

Now all that has changed with the big drop in household wealth, the drop in what households own. And households are responding by making big changes to their financial behavior. For the first time since World War II, households are paying down on their debt and reducing their total amount owed.

Saving is also making a comeback. After falling to nothing (0 percent) a couple of years ago, we're now saving more than 3 percent out of our paychecks. While modest, this still represents a significant shift in financial behavior.

Yet will it continue? Is saving now in and borrowing out? Many observers think the answer is yes. They think the 20 percent drop in household wealth is acting as a shock to the system. Households will remember the foreclosures, bankruptcies and lost investment balances of the late 2000s. And investment markets like stocks and homes aren't expected to return to their go-go growth days of years past. The modest gains in household wealth will serve as a check on borrowing.

So if we are entering a new financial era, one where people first save before they buy rather than charging it, will it be good or bad for the overall economy? As with many things in economics, there will be pluses and minuses.

If saving goes up and borrowing goes down, certainly more households will be in better financial condition. Yet at the same time, since households are responsible for almost three-quarters of total spending in the economy, less spending means reduced business opportunities and fewer jobs.

So is there no way out? Do we risk financial meltdowns if households borrow and spend, but sluggish growth and high unemployment if they don't? Fortunately, there's a third option. This is to use the savings generated by households to invest and grow the economy, thereby increasing income. And higher levels of income can support both more saving and more spending - a win-win.

The key question then, is how do we create the conditions for option three? That's the multi-trillion dollar question that we'll all have to decide together!


Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at

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Posted by Dave at April 3, 2009 08:00 AM