Household assets take sting out of debt level

ECONOMICS:THE WORLD is awash with debt. The Irish economy is up to its neck in it. Nobody believes that debt levels should do anything but fall. But analysing debt always needs broader balance sheet context. To see why, consider a (somewhat simplified) example from personal finance.

Seán is on the average industrial wage. He owes €500,000. If Seán had no assets he would probably be in the soup. If, on the other hand, he had €10 million in stocks, property and cash in the bank he would be sitting pretty – having €500,000 on the liability side of his balance sheet would be barely consequential.

These alternative scenarios show that discussing debt without looking at the asset side of balance sheets is one-dimensional, if not meaningless.

The Central Bank has recently begun publishing its tots of the value of all the assets of Irish individuals (described as “households”) along with their combined debts. The chart shows how the aggregate balance sheet of all Irish households has evolved over the course of bubble and bust.

Liabilities first. In just over six years from 2002, household debt rose more than threefold, from €66 billion to €212 billion at peak in 2009. This was insane even by the standards of the years up to 2007/08, when debt levels rose rapidly in almost all rich countries. Although household debt has since fallen by €20 billion, in only a handful of other countries is it higher than in Ireland.

The borrowing binge mostly went into property, inflating a house-price bubble. That brings us to the asset side of the balance sheet. By the end of 2007, Irish households’ combined property assets peaked at €609 billion. As of September last year, the value of property assets had fallen to €362 billion.

If Irish households’ property assets have been hammered, their financial assets have proved far more stable. As of September last, households’ financial assets were worth €300 billion. As the chart shows, this is broadly in line with the height of the bubble-era in 2007.

These assets are grouped into three categories: banknotes and bank accounts; pension and insurance investments; and shares and other equity. The mix of the three varies hugely across Europe. In Ireland, the mix is approximately 40:40:20 across the three asset classes.

Irish households like being liquid. As of the end of September last year, they held €122 billion in cash and bank deposits. That was one-third more than one year’s disposable income. Across 21 European countries, only the Dutch hold more wealth in this form.

The value of pension and insurance investments stood at €120 billion at the end of the third quarter of last year. Between 2002 and 2008, the total value of these assets doubled. Then, as world financial markets went into a tailspin in September 2008, pension and insurance investments dipped sharply. But they have since recovered, largely because fund managers had diversified out of Irish assets, protecting households from the collapse in bank shares and the deep recession in this economy.

Of the 21 countries for which comparative figures are available, only the Dutch, the Danes and the British had more financial assets in pension and insurance funds.

Directly held equity, which includes foreign property and shares listed on the stock market, is the third broad category of household wealth. In 2007, its value reached €70 billion. By 2009, it had declined to €45 billion. Partly reflecting the banking fiasco, there has been little rebound since.

Putting all the pieces together, what does the full balance sheet say about personal wealth? At last count, households’ assets were worth almost 3.5 times their debts. While that may sound reassuring, it is much less than in peer countries. Belgians’ assets are worth 10 times their liabilities, the highest ratio of 14 European countries for which fully comparable figures are available.

Danes’ assets are lowest, at 2.8 times, while the Dutch and Norwegians are also lower than Ireland.

Irish households have lots of debt and they have suffered a bigger decline in the value of their assets than their peers elsewhere in Europe. This is unquestionably hampering recovery and has rendered far too many people insolvent.

More aggressive restructuring of those who are hopelessly in debt is needed, but mass household bankruptcy does not appear to be on the cards.