Americans’ debt shrinks – 1st time ever

Americans’ debt shrinks – 1st time ever

Household debt falls by 0.8% as Americans’ net worth falls by largest amount on record on declining home and stock prices.

By David Goldman, CNNMoney.com staff writer
In a sign that Americans’ spending habits are shifting, their household debt fell for the first time ever, as their net worth declined by the largest amount on record based on data going back to 1951.

According to the Federal Reserve’s flow of funds report released Thursday, consumer debt fell an annualized $30 billion, or 0.8% in the third quarter to $13.91 trillion.

Americans holding less debt may sound like a positive, but it also means consumers are spending less, as debt has become more expensive and harder to come by.

As the credit crunch intensified in the third quarter – and exploded late in the period with the bankruptcy of Lehman Brothers – Americans were increasingly unable to finance big purchases like homes, cars and big-ticket goods.

“Interest rates have shot rapidly higher in the last few months, and people are borrowing less because they don’t want expensive credit hanging over their heads,” said Michael Englund, chief economist for Action Economics. “The other component is the credit crunch, where qualified borrowers are unable to get credit.”

That’s a worrisome sign for the economy, as consumer spending makes up 70% of overall U.S. gross domestic product. The economy entered a long and deep recession in December 2007, and the prospect of a turnaround will weigh heavily on consumers’ confidence to spend money.

“Everyone over the past three months decided to become thrifty at the same time, but our incomes depend on other people spending,” said Englund. “If we all start saving and cut back on our spending at the same time, it means more people will ultimately get fired.”

The U.S. economy has shed 1.9 million jobs so far in 2008, with precipitous declines since September. As more Americans keep their wallets closed, Englund said the economy has entered a vicious cycle, in which Americans spend less and have less to spend.

And fourth-quarter debt data is likely to be even lower, as the peak of the credit crisis came in mid-October.

“There has been a particularly steep rise in the savings rate recently,” said Englund. “With a large part of thriftiness due to panic, this trend could continue for a long time.”
Net worth in 12-month tailspin

Consumers watched their net worth decline for the fourth quarter in a row as it dropped by $2.8 trillion, or 4.7%, to $56.5 trillion, dragged down by precipitous declines in home values and the stock market. It was the largest decline in the 57-year history of the report.

The first quarter’s decline follows wealth declines of $393 billion in the second quarter, $2.4 trillion in the first quarter and $1.5 trillion in the fourth quarter of 2007. Until then, net worth had been rising steadily since 2003, climbing nearly 31% over those five years.

The four quarters of declines have resulted in a net 11.1% decline in Americans’ wealth in the last 12 months. During the bear market of 2000 through 2002, household’s net worth dropped just 6.2%.

The net value of financial assets for households fell by $2.1 trillion, or 4.4%, led mainly by declines in stock holdings and mutual funds.

Americans’ share of corporate equities plummeted $943.5 billion – an 11.5% drop – in the quarter to $7.3 trillion. With major stock indexes like the S&P 500 falling 40% or more since January, shares of mutual funds, a primary investment of 401(k) retirement funds, declined $597.4 billion, or 12.4%, to $4.2 trillion. more

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