Consumer Finance Issues in the Wake of the Great Recession Richard M. Todd Vice President, Federal...

Consumer Finance Issues in the Wake of the Great Recession

Richard M. ToddVice President, Federal Reserve Bank of Minneapolis

Pathways to Financial Success ConferenceWisconsin Dells, WI

June 16, 2011

The views expressed here are Mr. Todd’s and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System

Overview After the bursting of an asset and debt boom, Extension professionals have an important role to play in helping

many households adjust to life with less wealth, less credit, reduced income, and significant uncertainty.

• Boom: Asset appreciation boosted wealth and debt• Bust: Falling asset prices, debt problems, recession• Recovery: Slowed by wealth and job losses, debt

problems, and uncertainty• Extension: Help families and communities recover

2

Key Features of the Boom

• Household asset values and debt both surged• Financial institutions increased leverage and

added off-balance-sheet exposures• Government budget exposures mounted,

many of them also off-balance-sheet• Result: High risks and vulnerabilities• Government policy and regulation contributed– Subsidies and guarantees– Regulatory avoidance

3

Housing Appreciation Accelerated till 2006(FHFA Index, 1991=100)

4Source: Federal Housing Finance Authority, Seasonally-Adjusted Purchase-Only Indices (1991Q1=100)

Consumer Debt Peaked in 2007(household and nonprofit liabilities as % of disposable income)

5Source: Federal Reserve Board of Governors, Flow of Funds, Table B.100

Role of Government Policy & Regulation

• Subsidies and guarantees– Tax treatment of mortgages– Deposit insurance

• Regulatory avoidance– “shadow bank” system– “too big to fail”• Large or complex banks and insurance companies• Fannie and Freddie

• Regulatory failures

6

Key Features of the Bust

• Falling household asset values led to delinquencies

• Financial institutions deleveraged and sought safe liquid assets, triggering a shadow bank run and disrupting the whole world economy

• The Great Recession, with big adjustments for households, financial institutions, and governments, ensued

• Government borrowing surged, with “bailouts” small compared to loss of tax revenue and safety net and stimulus spending

7

Housing and Stock Prices Plunged

8

Household Net Worth Plummeted

9Source: Federal Reserve Board of Governors, Flow of Funds, Table B.100

A Financial Run Ensued• By 2008, some large lenders

were failing• Investors feared more risks,

cut short-term loans• Fed, Treasury, FDIC

intervened massively to calm the “shadow bank” run

• Still, the volume of short-term funding and asset-backed lending fell sharply in late ’08 and early ‘09

Rate spread: 1-month Euro$ deposits over U.S. Treasuries

10

For more details, see Niel Willardson and LuAnne Pederson, "Federal Reserve Liquidity Programs: An Update" at www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4451

Financial Woes Help Turn a Recession into the Great Recession

11Source: http://www.minneapolisfed.org/publications_papers/studies/recession_perspective/index.cfm

part three

• Boom: Asset appreciation boosted wealth and debt

• Bust: Falling asset prices, debt problems, recession

• Recovery: Slowed by wealth and job losses, debt problems, and uncertainty

• Extension: Help families and communities recover

12

Goal: Get Back to Trend Growth

13

Source: Robert E. Lucas, Jr. “The Recession of 2007-201?” www.econ.washington.edu/news/millimansl.pdf

Source: Robert E. Lucas, Jr. “The Recession of 2007-201?” www.econ.washington.edu/news/millimansl.pdf

We’ve Got a Big Gap to Make Up

14Source: Robert E. Lucas, Jr. “The Recession of 2007-201?” www.econ.washington.edu/news/millimansl.pdf

Rising Income Is Lifting Spending Some(and equipment/software investment, manufacturing and trade)

15

But the Job Market Is Still Lagging

16For comparable data: www.minneapolisfed.org/publications_papers/studies/recession_perspective/index.cfm

Recovery Held Back by HH Losses, Debts, and Uncertainties

• Wealth Loss from Asset Price Declines– Housing– Equities

• Unemployment and Income Loss from Recession• Mortgage Stress– Under water– Delinquent– Foreclosed

• Uncertainty

17

HH Wealth Losses Were Significant

• Median wealth down: $125K in ’07; $96K in 09• Mean wealth down: $595K in ‘07; $481K in ‘09• Median % change was an 18% decline• Wide diversity across families • Wealth fell >50% for a quarter of families• Wealth rose >25% for a quarter of families• Asset value declines biggest factor, esp. homes• Wealthiest lost most in $; leveraged lost most in %• Losses largest in the West, lowest in Northeast

18Source: Bricker et al., “Drowning or Weathering the Storm,” NBER WP 16985

Recession Added Unemployment & Income Cuts on Top of Wealth Losses

19Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession." www.newyorkfed.org/research/staff_reports/sr482.html

Mortgage Problems High, Esp. for Young

20Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession." www.newyorkfed.org/research/staff_reports/sr482.html

Mortgage Debt Problems Are High in WI% of Active Loans 90+ Days Delinquent or in Foreclosure(Source: Lender Processing Services Applied Analytics)

21

See http://data.newyorkfed.org/creditconditions/

Most Unemployed Have No Mortgage, But Those Who Do Are More Frequently Behind

[Distribution of Ownership and Mortgage Status (2008-09),by Unemployment Status of Respondent/Spouse]

22Source: Hurd and Rohwedder, “Effects of the Financial Crisis and Great Recession on American Households.” NBER WP 16407

Finding a Job Has Taken a Lot Longer

23Source: www.bls.gov/opub/ils/pdf/opbils89.pdf

Policy Uncertainty Is High and Reflects Our Fundamental Disagreements

• “Two Sets of Standards, One Big Muddle for SIFIs”American Banker 7 Jun 2011

• “Bernanke Agrees With Dimon That Dodd-Frank Rules Unclear” “

Dow Jones News Service 13 Jun 2011• “Geithner Wants Global Rules on Derivatives”

The Wall Street Journal Online 07 Jun 2011

• “Clock Ticking On New Rules”• The Wall Street Journal 7 Jun 2011

• "Tarullo Speech Stokes New Fears on Basel Capital Surcharge" American Banker 10 Jun 2011

• “The Uncertainty Tax” Thomas Friedman, New York Times 12 Jun 2011

• "ECB Stands Firm on Greek Debt" The Wall Street Journal 10 Jun 2011

• “California Voters Balk at Tax Plan" The Wall Street Journal 09 Jun 2011

• “Talks on Debt Limit To Heat Up Next Week” New York Times, 10 Jun 2011

• “Yes We Want To Cut the Budget. Just Not That Part” New York Times, 12 Jun 2011

24

Many Families Were Financially Stressed(unemployed, neg. equity, 2+ arrears on mortgage, or in foreclosure)

25Source: Hurd and Rohwedder, “Effects of the Financial Crisis and Great Recession on American Households.” NBER WP 16407

Budgets Often Stressed or Vulnerable

26Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

Overall, Losses Led to More Savings

27Note: Annual averages shown. For April 2011, the savings rate was 4.9%

On Average, Families Cut Food and Out-of-Pocket Health Care Spending

28Source: Hurd and Rohwedder, “Effects of the Financial Crisis and Great Recession on American Households.” NBER WP 16407

Stressed HHs Cut Spending More Deeply

29Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession." www.newyorkfed.org/research/staff_reports/sr482.html

Unemployed Reduced Savings Too(Where respondent or spouse unemployed, May ‘09 to April ‘10)

30Source: Hurd and Rohwedder, “Effects of the Financial Crisis and Great Recession on American Households.” NBER WP 16407

Income/Job Loss Cut Retirement Saving

31Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession." www.newyorkfed.org/research/staff_reports/sr482.html

1 in 13 Wisconsonites Took a Hardship Withdrawal (mid ‘08 to mid ‘09)

32Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

part four

• Boom: Asset appreciation boosted wealth and debt• Bust: Falling asset prices, debt problems, recession• Recovery: Slowed by wealth and job losses, debt

problems, and uncertainty

• Extension’s Role: Help families and communities recover

33

Many Households Want To Act Prudently (Intended Response to Abnormal Income)

Response to 1-Yr. 10 % Increase Resp)onse to 1-Yr. 10% Decrease

34Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession.“ www.newyorkfed.org/research/staff_reports/sr482.htm

Many Households Know Why To Save(Households’ “Very Important” Reasons to Save)

35Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession.“ www.newyorkfed.org/research/staff_reports/sr482.htm

But Many Report Reasons to Cut Savings

(% listing reason as moderately or very important, Nov. 2009)

36Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession.“ www.newyorkfed.org/research/staff_reports/sr482.htm

Few Are Happy with Where They Stand(Wisconsonites’ Satisfaction with Their Financial Condition, 2009)

37Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

Households Have Reduced Debt

38

(Financial Obligations and Key Components, as % of Disp. Income)

Source: Federal Reserve Board -- www.federalreserve.gov/releases/housedebt/default.htm

HH Delinquency Still High but Falling

39Source: www.newyorkfed.org/creditconditions/

Issues w. Credit Card Debt Common(mid 2008 to mid 2009)

40Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

Many High and Low Credit Scores in WI

41Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

Lack of Credit Self-Knowledge Accompanies Significant Income Risk

42Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

Savings and Planning Fall Short

43Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

Insurance Gaps – It’s Not Just Health(households w/o insurance, by type)

44Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

About 1 in 30 Wisconsonites Unbanked(among those whose responded)

45Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

Use of Alt. Financial Services Goes Beyond the Unbanked (mid ‘04 to mid ‘09)

46Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

Summary of Extension’s Roles

• Help families– Resolve debt problems and rebuild credit access– Make new plans after wealth and job losses– Budget and save successfully– Maintain or enhance financial services access– Retrain and maintain earning power

• Helping communities deal with– Lower trajectory for consumer spending– Vacant or under-used properties– Government and nonprofit budget cuts– High demand for workforce training

47

Federal Reserve Resources

48

www.federalreserve.gov/consumerinfo/foreclosure.htm

www.federalreserve.gov/communitydev/default.htm, and