1209 Household Del Ever Aging Dynan

8/8/2019 1209 Household Del Ever Aging Dynan

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Household Deleveraging and theOutlook for Consumer Spending

Karen Dynan

Brookings Institution

December 8, 2010

This presentation was prepared for the Macroeconomic Advisers, LLC 109th Quarterly Outlook

Meeting in Washington, DC. The views expressed are my own and not necessarily those of others

affiliated with Brookings.


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Some Facts aboutThe Great Deleveraging


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Some of the deleveraging can be accounted for

by a reduction in new borrowing

0

200

400

600

800

1,000

1,200

0

50

100

150

200

250

99:Q1 00:Q1 01:Q1 02:Q1 03:Q1 04:Q1 05:Q1 06:Q1 07:Q1 08:Q1 09:Q1 10:Q1

Newly Originated Installment Loan Balances

Billions of Dollars Billions of Dollars

Source: FRBNY Consumer Credit Panel

Auto Loan

(left axis)

Mortgage

(right axis)


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The enormous wave of loan defaults has also

contributed importantly to deleveraging

0

100

200

300

400

500

600

700

Home Mortgage Consumer

Deleveraging and Charge-offs, 2008:Q2-2010:Q2

Decline in Debt Estimated charge-offs less trend

Source: U.S. Flow of Funds accounts, G.19 release, and authors calculations.

Billions of Dollars


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State-level comparisons also underscore the

importance of defaults

Declines in debt much

larger in states thathave seen moremortgage distress(states in red haveserious delinquencyrates > 10%)

0

25

50

75

100

99:Q1 00:Q1 01:Q1 02:Q1 03:Q1 04:Q1 05:Q1 06:Q1 07:Q1 08:Q1 09:Q1 10:Q1

Thousands of Dollars

Total Debt Balance per Capita* by State

CA

NV

AZ NJ

FL

TX

OH

MINY

PA

IL

* Based on the population with a credit reportSource: FRBNY Consumer Credit Panel

Q3


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There is more deleveraging to come (I)

Different measures tellus different things

about how muchprogress weve made.

Some measuressuggest weve made a

lot of progress

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0.11

0.11

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0.12

0.13

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0.14

0.14

0.15

Household Debt Service Relative to

Disposable Personal Income

Source: Federal Reserve

Q2


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There is more deleveraging to come (II)

but other measures suggest weve made less progress

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0.12

0.14

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0.24

1980 1985 1990 1995 2000 2005 2010

Household Debt Relative to Assets

Source: U.S. Flow of Funds accounts

Q2

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1980 1985 1990 1995 2000 2005 2010

Household Debt Relative to

Disposable Personal Income


Q2


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There is more deleveraging to come (III)

and other indicators point to many more mortgage defaults.

Weak labor markets

Close to of mortgages

under water

< 500K HAMPmodifications; and manymay fail given averageback-end DTI of 63%

Large shadow inventory

of foreclosures 01

2

3

4

5

6

7

8

9

100

150

200

250

300

350

400

450

500

550

600

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Number of new foreclosures (in thousands, left scale)

% of mortgage balances 90+ days delinquent (right scale)

Source: Federal Reserve of New York. Last chart point is 2010:Q3

Mortgage Distress


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Deleveraging and Consumption


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The relationship between net worth and debt

Arithmetic link: net worth = assets debt

But, choosing more or less debt to finance thepurchase of assets doesnt lower or raise net worth

it just changes leverage (means that the same level ofnet worth can be associated with very different levelsof debt)

Lifecycle hypothesis says consumption should be a

function of net worth; no direct tie between the degreeof leverage and consumption


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Why might debt matter above and beyond its

influence on net worth?

Mishkins liquidity hypothesis: when the probability offinancial distress is high, you increase saving in order

to pay down debt or buildup a larger buffer of liquidassets

One factor that may precipitate financial distress:high debt payments relative to your resources

Mishkins story was that households choose toincrease saving, but a variant would be that financialinstitutions impose this on households by restrictinglending (dissaving)


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That said, it may difficult to detect a role for

debt in a macro model because there is solittle quarter-to-quarter variation

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1

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1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Household Balance Sheet VariablesRelative to Disposable Personal Income


Q2Debt

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1

2

3

4

5

6

7

8

9

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Household Balance Sheet VariablesRelative to Disposable Personal Income


Q2

Assets

Net Worth

Debt


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If we cant use a model, what

can we say about howdeleveraging is likely to affectconsumption growth?


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New borrowing should pick up and that

should be a positive for spending

Supply constraints easing:

Tightening of loan terms and standards beginningto unwind

Decline in credit limits has tapered off

Possibility of some sort of government programthat would allow more homeowners to refinanceand take advantage of low mortgage rates


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-20

-10

0

10

20

30

40

50

60

70

80

NetPercentofBanksTig

htening

Standards

Banks Tightening Consumer Lending Standards

Q4

Other Loans

Credit Cards

Source: Fed Senior Loan Officer Survey


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0

1

2

3

99:Q1 00:Q1 01:Q1 02:Q1 03:Q1 04:Q1 05:Q1 06:Q1 07:Q1 08:Q1 09:Q1 10:Q1

Trillions of Dollars

Aggregate Credit Card Limit



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Caveat regarding new borrowing: what about

demand effects?

Recall that Mishkins story hinged on householdsviews about whether they had sufficiently reduced the

probability of financial distress

Hard to assess: this is where micro data onbalance sheets (or even just good survey data onattitudes) would be really helpful

Fact that loan originations picking up suggests thatsupply effects may be more relevant


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Further mortgage defaults could be a positive or

negative for the spending of those who default

Relieved of onerous debt payments.

Probably a positive

Though households still generally have to pay fornew housing

One mystery here is this should imply a smallerdecline in the FOR than the DSR and thats notwhat we are seeing (next slide)


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0.10

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Household Financial Obligations Relative to Income

Source: Federal Reserve

Q2

Total Financial Obligations

Debt Service


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Hit to credit scores from defaulting

Should be a negative: for example, Han and Li(forthcoming, JMCB) found bankruptcyassociated with reduced access to unsecureddebt and higher cost of borrowing generally

Interesting, though, that credit score measureshave not changed that much (next slide)

Further mortgage defaults could be a positive or

negative for the spending of those who default(contd)


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500

550

600

650

700

750

800

850

900

99:Q1 00:Q1 01:Q1 02:Q1 03:Q1 04:Q1 05:Q1 06:Q1 07:Q1 08:Q1 09:Q1 10:Q1

1st Quartile

Average

2nd Quartile

3rd Quartile

Equifax Risk ScoreSM Distribution


Q2


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However, the biggest issue about further

mortgage defaults may not be the direct effects

Rather, the biggest issue for consumer spending isprobably the risks related to indirect effects:

More charge-offs could hurt the still-fragile bankingsystem, and, in turn, cause banks to pull backagain on lending

REO properties could flood the housing market andinduce a significant further decline in home prices,producing another round of negative wealth effects


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Concluding thoughts

Deleveraging has held back the recovery, but unclearthat it will hold down future consumption independent ofwealth effects

Over the longer-run, deleveraging will leave householdsin a more sustainable position and reduce the likelihoodof another crisis

As we go forward with credit regulation, we need to bear

in mind that an overly restrictive credit environment couldhave negative consequences for macro dynamics:Dynan, Elmendorf and Sichel (2006): greater access tocredit contributed to reduced macro volatility betweenmid-80s and mid-00s

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1209 Household Del Ever Aging Dynan