By Dr. Uric Dufrene, Sanders Chair in Business Professor of Finance, Indiana University Southeast
Talk about an upcoming recession has been only intensifying. A recent recession indicator at Bloomberg placed the odds of a recession at 100%, and one frequently cited recession indicator, an inverted yield curve (which means short-term Treasury yields are higher than longer-term yields) also points to a recession. If we do believe that a recession is imminent, one question to ask is whether it will be a deep or mild recession. Given that the consumer is almost 70% of the U.S. economy, the state of the consumer will help determine the severity of any economic slowdown. If we agree with some of these recession indicators and one is imminent, it will be mild compared to previous recessions.
Not counting the Covid recession, one of the most severe recessions was the Great Recession from 2007 to 2009. The recession originated with disruptions in the mortgage market with certain types of mortgage-backed securities and then spread to other corners of the financial markets. The official starting date of the recession was December 2007. One characteristic of this recession was the significant decline in household net worth. Southern Indiana did not observe the big price declines in home values, but other regions experienced significant wealth destruction due to plummeting home values. In addition to the loss of real estate wealth, households also saw big declines in stock equity values. The combination of losses through home values and the stock market led to a big drop in household net worth. It then took another five years to fully recover the loss of net worth. This decline in household wealth caused the consumer to retrench, and consumer spending saw significant declines. It took about 4 years for retail sales to get back to pre-recession levels.
In contrast, household net worth saw a smaller drop during the Covid recession, and value was fully recovered in less than 6 months. After that initial recovery, net worth then exploded, experiencing the biggest two-year increase in the past 30 years. Recent stock market turbulence has since produced a decline in net worth, but levels are still high relative to historic numbers.
One implication of this is that households are better prepared to experience a recession. This is one of the reasons why any impending recession will only be mild.
Net worth is only one measure of consumer health, but others draw similar conclusions regarding consumer readiness for a recession. One measure is the consumer debt situation. Household debt, as a percentage of household income, has been increasing. It reached the lowest level in 30 years back in 2021 when consumers were flush with cash from government stimulus programs. Since then, household debt has been increasing. However, levels remain under pre-pandemic levels and lower than the past two recessions prior to Covid.
Even though household debt has been on the upswing, it is under control. Delinquency rates on credit cards and consumer loans remain the lowest in the past 30 years. Delinquency rates declined during Covid and have experienced upticks this past year. Rates are still under pre-Covid delinquency rates and remain at the lowest in 30 years.
Covid saw the highest savings rates going back to the 1960s, and perhaps among the highest of all time, approaching 35% back in 2020. Consumers did not have many places to spend or enjoy services, like dining and travel. This behavior, combined with government stimulus, produced sky-high savings rates. Savings rates have come down considerably since. The savings rate is well under the level that existed at the start of Covid and is comparable to a savings rate just before the Great Recession. The difference between now and then is with the level of checkable deposits. While savings rates have come down, checkable deposits are at record levels. The additional cash that households have accumulated will serve as a buffer for any economic downturn.
With gains in home values, households are experiencing record home equity levels, but the volume of home equity loans remains at low levels. This means that the household has unused debt capacity and will be able to tap into this wealth. Higher mortgage rates will discourage use of home equity, but it does remain a source of cash for the household.
Another factor that supports a shallow recession is the state of the consumer due to the labor market. The unemployment rate will increase during a recession, but this is from an already low rate of 3.5%. Job openings remain at very high levels relative to the number of unemployed with 1.7 job openings available for every unemployed person. Job openings will also come down, but openings will also soften the blow of an economic slowdown.
If we do enter a recession, the household is favorably positioned to weather the storm. Consequently, the recession will be mild and not nearly as deep as the Great Recession of 2007.