Over the past 10 years, U.S. homeowners collectively experienced the very highest highs and the very lowest lows of home ownership, according to experts from the Federal Reserve Bank of St. Louis.
The two – Ray Boshara, a senior adviser at the Fed’s Center for Household Financial Stability – and William Emmons – chief economist at the Center for Household Financial Stability and an assistant vice president and economist at the Fed – recently performed a study, “After the Fall: Rebuilding Family Balance Sheets, Rebuilding the Economy.”
In their in-depth look inside the homes of families during the Great Recession of 2007-2009, Boshara and Emmons discovered rich data and new research to support the damage to household balance sheets. Specifically, says Boshara, they were able to show which demographic groups lost the most wealth following the recession and illustrate how economically vulnerable groups possessed especially risky balance sheets going into the crisis.
“We then addressed the importance of balance sheet health at the micro level,” said Boshara. “That is, the importance of sound financial footing to families. Finally, we reviewed research on the importance of healthy household balance sheets to the economy.”
Looking back as to which demographic groups in American society were the most vulnerable heading into the Great Recession as homeowners, Boshara says the Fed’s data suggests that families that were younger, had less than a college education and/or were members of a historically disadvantaged minority group – African Americans or Hispanics of any race – suffered particularly large wealth losses.
“Even before the crisis,” said Boshara, “younger, less-educated and historically disadvantaged minority families were known to be among the most economically vulnerable groups because of the particular occupations and sectors in which they were over-represented, such as low-wage service-sector jobs and construction. What was not well-known,” he added, “but which we document in this study, is that families in these economically vulnerable groups also had very risky balance sheets going into the crisis. Our research suggests that both economic vulnerability and risky financial choices may stem from one or more common causes, including education, employment, housing and credit markets. These groups experienced the most ‘acute’ balance sheet failures: high concentrations of wealth in housing and high levels of debt.”
Housing represented a relatively large share of total assets among economically vulnerable groups, Emmons says, and the pattern is true among white and Asian families as well according to age and educational attainment; in general, he says the younger the family and the lower the level of educational attainment, the more economically vulnerable the family was when the housing market collapsed.
“The difference in housing portfolio shares between the economically strongest subgroup – older college-educated families – and the economically weakest – younger high school dropouts – is an enormous 41 percentage points,” said Emmons, “making the latter group much more vulnerable to a housing market decline.”
Prior to 2007-2009, says Boshara, many respected economists weren’t worried about the management of household balance sheets and the role balance sheets played in overall economic performance. “This may have been due to the lack of recent historical evidence suggesting that household balance sheet failures – such as high concentrations in housing or high levels of debt – actually harmed the economy,” he said. “Many policymakers thought that any household balance sheet problems would largely work themselves out on their own. It has come as somewhat of a surprise, therefore, that many economists now are calling the Great Recession of 2007-2009 a ‘balance sheet recession’ and that balance sheet failures are seen as important contributors to the downturn and weak recovery.”
Two key aspects of the current economic cycle, 1) wealth effects and 2) defaults and deleveraging, explain what’s going on, according to Emmons.
Wealth effects are how much a one-time, unexpected change in the value of a household’s assets might affect their spending, both in the short-term and in the long-term. Emmons says that in recent years, economists estimate that an unexpected, one-time increase of just 1 percent in housing wealth led to an increase of 0.08 percent to 0.12 percent in consumer spending each year afterward. In contrast, the same increase in financial wealth was followed by a less than 0.03 percent permanent increase in consumer spending.
Defaults and deleveraging are two distinct but related ways, says Emmons, in which the liability side of household balance sheets may have harmed the economy in recent years. Residential mortgage loan defaults that discharge debt in excess of the collateral that banks have acquired result in a loss to those lenders; the concentration of these losses, he says, at highly leveraged financial institutions, appears to have macroeconomic significance.
Emmons cites the predictions of economist Jan Hatzius, who looked for a huge reduction of 2.6 percentage points in real GDP growth in both 2008 and 2009 from a baseline of about 2.5 percent annual growth. “Hatzius predicted roughly zero growth for the two years,” Emmons said. “As it turned out, real GDP fell 0.3 and 3.1 percent in those years, somewhat worse than he predicted.”
As a result of the findings of its research study on family balance sheets and the Great Recession, the Federal Reserve Bank of St. Louis’ Center for Household Financial Stability is proactively assessing and monitoring the health of household balance sheets, including the creation of new data warehouses and indexes.