Impact of market losses could rise

Dec. 27, 2002 - Quick, which of the past three years was the worst on the stock market? That’s right: Barring an end-of-year miracle, 2002 will go down as the worst year for equities since 1974.

As of Thursday the Wilshire 5000, considered the broadest measure of stock market wealth, was down more than 21 percent for the year, compared with about 12 percent each in 2000 and 2001. That means the stock market has erased $2.7 trillion in market value this year, and a total of $7.3 trillion since its peak in March 2000.

OK, if you’ve been opening your brokerage statements regularly that might not rank as especially startling news. But the cumulative effect of the market’s deepening losses has had a significant impact on household balance sheets. And that means the economy could suffer an increased drag next year from the so-called negative wealth effect, said Paul Kasriel, director of economic research at Northern Trust in Chicago.

“It is starting to have an impact,” Kasriel said.

During the last major bear market of 1973-74, far fewer people owned stocks, and most workers could count on defined-benefit pensions — so many dollars per month for each year of service.

“Now more and more people have their pension plans in 401(k)s, and they are their own pension fund manager,” Kasriel points out. “The cumulative effect, plus the larger drop in equity values, has finally awakened households to the fact that they’re poorer and their nest eggs are not once they once were.”

Although it pales in comparison to more fundamental factors like changes personal income and employment, the negative wealth effect has been a recurrent concern of analysts and policy-makers over the past three years. Difficult to measure or prove, the wealth effect — and its negative corollary — refers to the tendency of people to spend more or less depending on how much is in their various bank and brokerage accounts.

Only about half of U.S. households have any money invested in the stock market, but any significant decline in their spending would be a major blow to the economy. Federal Reserve Chairman Alan Greenspan frequently has addressed the issue in congressional testimony and other appearances but contends that so far any negative impact has been mostly offset by continued growth in home values.

HOUSEHOLD NET WORTH DOWN

Yet rising home prices have not been nearly sufficient to offset the latest year of losses. According to the Fed’s latest figures, household net worth fell $2.756 trillion, or 6.7 percent over the first nine months of 2002. That was more than twice as much as the total household net worth lost in 2000 and 2001. And Kasriel points out that many home owners have traded in at least part of their increased home equity for additional debt through cash-out mortgage refinancings.

The negative wealth effect is one factor being blamed for what most experts agree was the weakest holiday retail season in at least five years.

“The consumer really got knocked off her feet by the collapse of the stock market,” said Ira Kalish, chief retail economist at Retail Forward, a consulting firm.

The negative wealth effect also appears to be driving an increase in the household savings rate, which has risen to 3.9 percent of disposable personal income this year from 2.3 percent last year. And it could go far higher: From 1952 to 1994 the personal saving rate averaged 8.7 percent, Kasriel said.

“Households are starting to clean up their balance sheets, but they have a long way to go,” he said.

There is nothing inherently wrong with households exercising some financial prudence. But every dollar saved is a dollar not spent, and that could spell trouble in an economy where consumer spending is responsible for two-thirds of all output.

That is one reason Kasriel considers it imperative that Congress provides some additional tax relief next year.

“Of course that just transfers debt from the household sector to the government sector,” he said. “But the government sector is better positioned to take on more debt right now.”