Household net worth sinks $11.2 trillion

NEW YORK (CNNMoney.com) -- Household net worth in the United States declined by $11.2 trillion last year, according to a government report issued Thursday, and Americans curbed their spending as they watched the value of their assets fall.

The Federal Reserve said household net worth, which is the difference between assets and liabilities, sunk by $5.1 trillion in the fourth quarter to $51.5 trillion. It was the sixth straight quarterly decline from the peak of $64.4 trillion in the second quarter of 2007.

The drop in net worth in the fourth quarter of 2008 was the largest drop in dollar terms on record, going back to 1951, when the government began keeping quarterly records. The 9% drop was also the largest drop as a percentage change on record.

The downward spiral in net worth was lead by a plunging stock market and collapsing home values.

The Dow Jones industrial average and the S&P 500 index have both been struggling to recover from 12-year lows. According to the Flow of Funds Accounts report, the value of U.S. equity shares at market value plunged to $12.1 trillion in 2008, down 41% from $20.6 trillion at the end of 2007.

Meanwhile, homeowner equity decreased to 43% of their household real estate by the end of 2008. That compared to 48.8% at the end of 2007 and 58.5% in 2005.

The U.S. economy fell deeper into recession as 2008 drew to a close and, as Americans watched their wealth deteriorate, debt spending slowed.

The report "reveals a U.S. consumer that can't cut debt fast enough relative to the drop in income and net worth," said, Peter Boockvar, an equity strategist at Miller Tabak, in a research note to clients.

Prior to this recession, Americans had based their spending habits on their perceived wealth in stock market portfolios and homes, Boockvar said. He said household debt as a percentage of disposable income has been on the rise in the past ten years, as has household debt as a percentage of net worth.

"This highlights the flip side of having an asset dependent economy where spending decisions are based more on the value of one's home and/or stock portfolio rather than the savings one has in the bank," he wrote.

The Fed said household debt in the fourth quarter contracted at an annual rate of 2%, marking the first quarter that debt has shrunk. Household debt fell by $69.7 billion to $13.8 trillion dollars in the fourth quarter. The government initially reported that household debt contracted by 0.8% in the third quarter, but that reading was revised to a 0.2% gain.

For all of 2008, household debt ticked up 0.4%, and that represented a significant slowdown from the year prior, when Americans pumped up their debt by 6.6%.

One of the primary components of household debt for most Americans is mortgage debt. Tighter lending standards in the wake of the credit crisis have made it harder for Americans to buy new homes.

Home mortgage debt shrunk at an annual rate of 1.6%, according to the report. That 1.6% drop came on the heels of a revised 2.3% drop in home mortgage debt in the third quarter. Home mortgage debt stood at $10.5 trillion at the end of 2008.

With unemployment at a 25-year high, Americans are also avoiding additional consumer debt, such as from credit cards.

Consumer credit plunged at an annual rate of 3.2%, the first quarterly decrease since the second quarter of 1992, when consumer credit dipped by 0.9%. By comparison, in the mid-nineties, consumer credit increased at a double digit percentage clip each quarter.

As Americans pulled back on spending, they socked more away in the bank. Household deposits rose $212.1 billion to $7.7 trillion in the fourth quarter of 2008.