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Economy in Brief

Households, Corporations and Banks Are in Good Shape as Recession Looms
by Paul L. Kasriel  October 17, 2022

To quote Mark Twain, "The report of my death was an exaggeration." I just have not had anything to say that tickled my fancy as I have watched the Fed drive the US economy toward a recession, which I think will commence in Q1:2023, as it tries to compensate for the policy error it committed in 2020-2021. Although I believe a 2023 recession is inevitable, I also believe that it will be a relatively mild one because the latest data available suggest that the balance sheets of households, nonfinancial corporations and commercial banks are in good shape. Admittedly, the latest data available are somewhat dated, being Q2:2022 for households and nonfinancial corporations and Q1:2022 for commercial banks.

Let's start with households. Plotted in Chart 1 are quarterly values of domestic deposits plus money market funds held by households as a percent of the dollar amount of household loans outstanding. As of Q2:2022, household deposit/money market fund assets were 101.0% of the amount of their outstanding loans. In Q4:2007, the peak in the business cycle before entering the Great Recession, this ratio was only 57.0%. Thus, households are cash rich as we slip into the next recession.

Chart 1

The Fed's massive creation of credit starting in March 2020 and the attendant decline in the structure of interest rates set off a housing boom. However, unlike the housing bubble of the mid 2000s, the most recent housing boom has been accompanied by stricter credit standards by mortgage lenders. As important, homeowners' equity as a percent of the value of residential real estate as of Q2:2022 is the highest since the mid 1980s. This is shown in Chart 2 below. Thus, as house prices decline and the unemployment rises in the coming recession, mortgage defaults would be expected to be much smaller than what occurred after the housing bubble burst starting in 2007. Fewer mortgage defaults, in turn, would imply fewer problems for mortgage lending institutions.

Chart 2

In general, households are better able to meet their financial obligations as of Q2:2022 than they have been going into any recession starting with the 1980 recession. Financial obligations are defined as debt service payments on home mortgages and consumer loans, motor vehicle lease payments, residential rent payments, homeowners' insurance premiums and property tax payments. Quarterly observations of financial obligations as a percent of disposable personal income are plotted in Chart 3.

Chart 3

Not only are households in good financial shape to weather the coming recession, but so too are commercial banks. Commercial banks were well capitalized as of Q1:2022 compared with what they were going into the 2001 and 2008 recessions. This is shown in Chart 3 below. Thus, the commercial banking system's ability to provide credit would not be expected to be capital constrained as it was in the 2008 recession.

Chart 4

Lastly, just as households are cash rich, so too are nonfinancial corporations. Plotted in Chart 5 are quarterly observations of the sum of domestic deposits, money market mutual fund shares and security repurchase agreements held by nonfinancial corporations as a percent of their debt securities and loan obligations. As of Q2:2022, this ratio stood at 21.4%, higher level than any going into a recession since the 1970 recession.

Chart 5

In sum, the balance sheets of households, nonfinancial corporations and commercial banks were in good shape earlier this year. Although balance sheets likely have deteriorated subsequently, it is doubtful that they have deteriorated to the levels that prevailed prior to the 2008 recession. Thus, the depth of the coming 2023 recession would be expected to be much shallower than that of the 2008 recession.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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