The Real Economy

After flush years, households show a reluctance to borrow

May 01, 2023

Key takeaways

A pillar of the economic recovery has been strong household balance sheets.

Households have held on to approximately $4 trillion in liquid financial assets. 

But as a slowdown looms, households are reluctant to take on debt.

Economics The Real Economy Inflation

A pillar of the American economy in the recovery from the pandemic has been household balance sheets, which have been bolstered by a robust labor market and nominal income growth.

But now, with the prospect of tighter lending standards and reduced spending caused by the recent banking turmoil, it is time to take a closer look at household finances.

The data suggests that household balance sheets, along with corporate capital expenditures, have contributed to the resilience of the domestic economy and have spurred its modest growth, so far keeping a mild recession at bay.

Households have held on to approximately $4 trillion in liquid financial assets over the course of the pandemic assistance programs. Because households waited for the all-clear signal at the end of 2021 before spending again, their balance sheets are arguably in better shape than at any time since the early 1990s.

At the end of last year, households were sitting on roughly $1 trillion in excess savings alone, by our estimation.
But as these flush households face the potential of an economic slowdown, they are reluctant to take on debt. Instead, households appear to prefer precautionary saving in contrast with overconsumption.

The upper two quintiles of households, which account for roughly 60% of overall spending, are most likely sitting on more than half a trillion dollars in excess savings alone.

While most households benefited from the pandemic assistance programs either directly or indirectly, not all income groups are expected to fare as well once those programs end.

Specifically, inflation has taken a far greater toll on low-income households as they face higher food and energy costs.

Below, we look at households and their propensity to take on debt, concluding that households entered this year with a solid financial foundation and now want to maintain that status by avoiding additional debt.

Household liquidity

On a broad basis, household holdings of easily accessible funds—bank deposits and money market funds—surged during the pandemic before declining slightly in the second half of last year.

Assuming that the pre-pandemic growth in bank deposits and money market funds has continued, we think that available funds currently total $4 trillion more than would have been expected before the pandemic.

If, as we anticipate, an economic slowdown occurs in the second half of this year, those liquid funds should act as a cushion for at least a segment of the population.

And because household spending is the major component of economic activity, we can expect a relatively shallow recession or even just an economic slowdown should inflation stay elevated.

Consumer liquidity*

Consumer liquidity*

Our baseline forecast for this year included a 65% probability of a recession induced by the Federal Reserve’s campaign to raise interest rates and tame inflation. That rate hike campaign is partly responsible for the recent banking turmoil and the probability of reduced lending.

Consider commercial bank lending. Those loans declined by roughly $105 billion during the final two weeks of March, the sharpest decline on record dating to 1973, when that data started being collected.

Almost all of that decline was driven by small banks.

The Dallas Federal Reserve found in its recent regional economic survey that lending standards have tightened overall. It is highly likely we will see other soft survey evidence in the near term before we see it transformed into slower economic activity or an outright contraction.

The source of household liabilities

The growth of total household liabilities tends to follow mortgage expenses. Mortgages have constituted 60% to 70% of total liabilities over the decades and now account for roughly two-thirds of all liabilities.

When interest rates were sent to near zero after the financial crisis, the yearly growth rate of mortgage expenses and total credit expenses decelerated rapidly.

We think that available funds currently total $4 trillion more than would have been expected before the pandemic.

During the recovery from 2011 to 2019, mortgage expenses increased along with house prices. When the demand for living space increased during the pandemic, mortgage liabilities accelerated before peaking last year.

In total, consumer credit has grown about 5% a year for most of the past two decades, except during and immediately after recessions. So the 7% growth of consumer credit last year is not all that high, coming off the low demand for credit in 2021 and reflecting a cautious outlook by households.

Growth rates of mortgage and consumer credit liabilities and total household credit market instruments

Growth rates of mortgage and consumer credit liabilities and total household credit market instruments

Balancing liabilities with liquid assets

Liquid assets available to households did not keep up with household liabilities from 1991 to 2019. But that all changed in 2020 and 2021, when Congress, in concert with the Trump and Biden administrations, kept businesses afloat, kept workers employed and pumped money into family balance sheets.

In addition, Russia’s invasion of Ukraine wreaked havoc with food and energy prices, while the pandemic altered the supply chain, the labor market and living choices. The result was a higher cost of goods and services.

That was closely followed by the bursting of the technology and crypto bubbles and the turmoil in the banking sector, all of which threatened the financial sector. Those events, combined with the Fed’s response to inflation, are likely to increase caution among households and precipitate an economic slowdown or a recession.

Household holdings of liquid assets and liabilities

Household holdings of liquid assets and liabilities

Reduced willingness to lend

The Fed’s survey of bank lending and lending standards confirms the increase in caution by both banks and lenders.

It makes sense that banks would indicate a greater willingness to make consumer loans during economic recoveries than they would during an economic downturn.

The most recent releases of the Federal Reserve’s Senior Loan Officer Opinion Survey, in October and January, correspond to both the lower supply of and lower demand for bank lending to households in the third and fourth quarters of last year.

As we show, the second half of last year would be the first time that banks indicated a decreased willingness to lend outside of a recession since the first loan officer survey in the early 1980s.

Supply of consumer loans*

Supply of consumer loans*

Consumer demand for loans falls

As it turns out, the unprecedented drop in the willingness to lend was matched by a drop in consumer demand for loans during the fourth quarter.

In fact, this is the first time since the depths of the pandemic that the loan officer survey was negative regarding consumer loans, credit cards, auto loans and home equity loans.

Demand for consumer loans*

Demand for consumer loans*
Commercial banking loans declined by roughly $105 billion during the final two weeks of March, the most on record. Almost all of that decline was driven by small banks.

Tightening mortgage standards

Surveys of lending standards and demand for mortgages are available only since 2015. As one would assume, banks have developed more stringent criteria for mortgage lending, particularly since the bursting of the housing bubble was the catalyst for more than 500 bank failures between 2008 and 2014.

The increase in banks reporting tightened lending standards for residential mortgages in the last three quarters of last year suggests rising caution by lenders and a drop in funds available for homebuyers.

Implied supply of residential mortgages*

Implied supply of residential mortgages*

Decreased mortgage demand

The tightening of lending standards also implies an increase in the cost of borrowing and an expectation for a decrease in the demand for mortgages.

Interest rates for 30-year fixed-rate mortgages more than doubled, from less than 3% in 2021 to more than 7% last year. Banks subsequently reported a steady decrease in the demand for mortgages.

Demand for residential mortgages*

Demand for residential mortgages*

Looking ahead

We expect the next loan officer survey, in May, to show mortgage rates drifting lower and a further moderation in demand for mortgages as households reach their limit on debt.

Given the recent financial instability and the increase in inflation, the maintenance of the 2020.21 accrual of liquid assets by households suggests a lower propensity to spend and a preference for precautionary savings.

Consumers have many reasons to remain cautious. We are far from the Federal Reserve’s 2% inflation target or the resolution of the war in Ukraine. We are also still affected by OPEC’s influence on oil supplies.

All those factors suggest that inflation will remain high and that the Fed will need to continue to keep interest rates elevated.

We can expect households to reduce spending as they factor in slower growth. All in all, a consumer pullback would curtail employment and further slow economic growth.

RSM contributors

Want more economic insights?

Subscribe to our monthly newsletter!

More from The Real Economy