Monday 24 October 2016

Household wealth goes on growing as debt is ground down

Published 15/05/2016 | 02:30

Irish household balance sheet
Irish household balance sheet

An important milestone in our return to economic normality has recently been passed. The amount of cash Irish households have sitting in banks rose back above the total amount they collectively owed to the banks.

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That deposits exceed loans is as it should be. In Ireland historically, and in most other developed countries, private individuals collectively have tended to have more in savings accounts then they have in borrowings.

Banks have typically used the surplus to lend to companies, arguably the most important function of the financial system.

Businesses, in contrast to households, tend to have lots more loans than cash on deposit - after all, why would you be in business if you could make a better return leaving your money in the bank rather than though borrowing to invest in your company?

From the point of view of a healthy banking system, it is a good thing that the ratio between deposits and loans to households has returned to more normal levels. As recently as five years ago, for every three outstanding euro there were in loans, only two euro were on deposit.

Bringing lending into line with deposits leaves banks less reliant on bond issuance for their funding. Over-issuance of bonds was one of the causes of banks lending too much money up to 2008.

Last week the Central Bank published its latest figures on the national balance sheet. The numbers give some great insights into corporate and banking sector balance sheets, but here today the focus will be on households only. I'll also widen out the discussion to include all the assets and liabilities of households, and not just those linked to banks.

Most analysis of economic developments focuses on the things that impact output and incomes - such as GDP, employment, wages, prices and the like. There tends to be less focus on cumulative saved income - that is, on wealth.

Analysing the wealth picture is not only important for what it says about the average person's personal finances, but also because of the way it impacts on how the economy grows. The most notable impact is the "wealth effect".

When people see the value of their assets rising, they feel better off, creating a positive wealth effect. This usually results in people being more inclined to spend and invest.

The corollary of this, of course, is a negative wealth effect. When people see the value of their assets falling, they pull in their horns - dampening economic activity.

Irish household wealth has been on a rollercoaster in the 21st Century, as the chart illustrates. When the Central Bank began collecting data in 2002, their net collective worth stood at €370bn (net worth, by the way, is calculated by adding up the value of all assets and subtracting all liabilities). It doubled in the following five years. It then fell by a third over the next five years.

As with so many other Irish economic indicators, the nadir was reached in 2012. In nominal terms, households experienced wealth destruction of almost €200bn during the crash - more than an entire year's GDP at the time. The collapse in property prices accounted for all of that destruction.

But since the low point in the second quarter of 2012, balance sheets have been painstakingly rebuilt. As of the end of last year, two thirds of the wealth that was destroyed has been clawed back.

Last week's figures show that in the 12 months to the end of last year, the collective net worth of households rose by €47bn. Although that was a decent increase, it was considerably smaller than in 2014.

The main reason for the slowdown in net worth growth was a cooling of property price inflation. Over the course of last year, the value of all housing assets owned by households rose by €28bn, exactly half the increase registered in 2014.

The cooling of the housing market is well known, but developments in financial asset values maybe more unexpected to readers. As the chart shows, the increase in the value of financial assets held by Irish households declined between the first quarter of last year and the final quarter. This was surprising. The launch of Quantitative Easing by the ECB early last year pushed up many assets prices, as was to be seen for instance in the 40pc rise of the Irish stock exchange index over the course of the year.

There are many different types of financial assets - from bank deposits to shares to pension holdings. Rather than over-burdening readers with the detail, suffice it say that I'm unconvinced that the downward move in the value of households' financial assets over much of last year is a trend. It seems that a few anomalies may explain the decline, although it warrants keeping an eye on.

Moving on to the liability side of the households' balance sheet (which is mostly composed of loans), further progress was made in 2015, as mentioned at the beginning of this column. The continued grinding down of debt last year brought to seven the number of years of deleveraging.

When all of the liabilities of households are added up they came to €158bn as of the end of last year. That was €10bn lower than a year earlier (and almost €60bn down on peak).

As a percentage of disposable income, that was the biggest decline in the EU. Household debt in Ireland between December 2014 and December 2015 fell from 180pc of disposable income to just over 150pc. While that amounts to good progress, Irish households remain the third most indebted in the EU (after those of Denmark and the Netherlands).

Another interesting aspect of the household wealth data relates to distribution across society. Unfortunately, the quarterly data from the Central Bank doesn't dig that deep - the latest information we have on wealth equality was published at the beginning of last year, providing a snapshot of 2013. Alas, it is the only such snapshot of wealth distribution that has been done by statisticians in Ireland (the only other attempt was a survey was done by the ESRI way back in 1987).

The wealth distribution figures showed a much bigger gap between the rich and poor than exists in incomes, and this is the case wherever wealth and income equality are measured. (That is because those on low incomes have much less to save and accumulate).

But it is worth noting that, in comparative terms, Ireland comes out in the middle of the fairness spectrum across Europe in terms of wealth distribution. Among other things, this demonstrates that the oft-parroted line - of Ireland being unusually unequal - is bunkum.

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