WASHINGTON (Reuters) - U.S. households suffered a record 9 percent drop in wealth and pared debt in the fourth quarter as a deepening recession battered confidence and finances, Federal Reserve data showed on Thursday.

Household net worth dropped by $5.1 trillion from the prior quarter to $51.5 trillion. For the full year, net worth dropped by $11.2 trillion, reflecting steep declines in the housing and stock markets.

The declines in household net worth were the largest since quarterly and annual records began in 1951 and 1946, respectively, said the Fed -- the U.S. central bank.

Since a second-quarter 2007 peak of $64.4 trillion, household wealth has dropped by about 20 percent, effectively wiping out four years of gains. That has put a chill on consumer spending and added to Americans’ anxiety about their economic well-being.

Michael Feroli, an economist with JPMorgan in New York, called the $5.1 trillion quarterly drop a “showstopper.”

“Given where the S&P 500 (stock index) is now and recent house price data, we estimate consumers have lost about another $2.5 trillion in the first quarter of the year,” he said.

The slump in wealth has coincided with an increase in the personal savings rate, which suggests households that had counted on rising real estate and stock market gains to replace traditional savings were now rebuilding rainy-day funds.

In the second quarter of 2007, when household wealth peaked, the savings rate was a low 0.3 percent. In the fourth quarter of 2008, it reached 3.2 percent. Many economists expect the percentage to at least double in the next couple of years.

But while economists have long warned that consumers were saving too little, a swift increase in savings in the midst of a recession can worsen the downturn. Consumer spending accounts for more than two-thirds of U.S. economic output.

WEALTH EFFECT

The Fed’s quarterly Flow of Funds report also showed that household borrowing shrank at a 2 percent annual rate in the fourth quarter after increasing at a 0.2 percent pace in the previous period, for the first quarterly decline on record.

Home mortgage debt fell at a 1.6 percent pace -- the third consecutive quarter of declines -- and consumer credit dropped at a 3.2 percent rate.

The build-up in household debt was one of the most striking elements of the five-year housing boom, which peaked in 2006. Consumers recorded double-digit annual increases in mortgage debt from 2001 through 2006, some of that in the form of cash-out refinancing that helped fuel strong spending.

Just how much rising wealth contributed to consumer spending is a subject of much debate but it is thought to be somewhere around 5 cents on the dollar. It is less clear how much households will cut back now that their wealth has been depleted.

Commerce Department figures released on Thursday showed retail sales fell modestly last month, which some economists saw as a tentative sign that spending could be stabilizing after a very weak fourth quarter.

But with so much wealth destroyed, credit conditions still tight, and households looking to pay down debt, spending is not likely to return to the levels seen during the boom years any time soon.

The figures also showed that the rate of growth in borrowing by businesses slowed to 1.7 percent from a 4.1 percent rate in the third quarter. The biggest jump in borrowing came from the federal government, coming in at a 37 percent rate in the fourth quarter.

At the end of the fourth quarter, domestic nonfinancial debt outstanding totaled $33.5 trillion, with households accounting for $13.8 trillion, nonfinancial businesses $11.1 trillion and government debt of $8.6 trillion.