Thursday, January 24, 2008

Why I Think We Will Have A Recession

Here is why I think we will have a recession. The graph above plots the Financial Obligations Ratio from the Board of Governors of the Federal Reserve. This ratio is an estimate of consumers' fixed payment obligations as a percent of their disposable income. Here is how the Board describes it:

The household debt service ratio (DSR) is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt.
The financial obligations ratio (FOR) adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance, and property tax payments to the debt service ratio.
So this ratio tells us the estimated percentage of the average person's disposable income that is already committed to making these fixed payments. The rest of the disposable income goes to pay for everything else including food, clothing, energy, education, savings, and so on.

The wavy line is the FOR for the third quarter of each year and the dark straight line is the trend line. I think this graph says a lot about why I hear people talking about being "tight" and not having extra income to spend lately. Add rising food and energy prices and I think there is just less truly discretionary money in the average household. This is also why I think any stimulus should be focused on consumers.

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