Consumer Finance Issues in the Wake of the Great Recession

1. Consumer Finance Issues in the Wake of the Great Recession Richard M. Todd Vice President, Federal Reserve Bank of Minneapolis Pathways to Financial Success Conference Wisconsin 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

2. OverviewAfter 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

3. 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

4. Housing Appreciation Accelerated till 2006(FHFA Index, 1991=100) Source: Federal Housing Finance Authority, Seasonally-Adjusted Purchase-Only Indices (1991Q1=100)

5. Consumer Debt Peaked in 2007(household and nonprofit liabilities as % of disposable income) Source: Federal Reserve Board of Governors, Flow of Funds, Table B.100

6. 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

7. 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

8. Housing and Stock Prices Plunged

9. Household Net Worth Plummeted Source: Federal Reserve Board of Governors, Flow of Funds, Table B.100

10. A Financial Run Ensued Rate spread: 1-month Euro$ deposits over U.S. Treasuries • 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 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

11. Financial Woes Help Turn a Recession into the Great Recession Source: http://www.minneapolisfed.org/publications_papers/studies/recession_perspective/index.cfm

12. 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

13. Goal: Get Back to Trend Growth 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

14. We’ve Got a Big Gap to Make Up Source: Robert E. Lucas, Jr. “The Recession of 2007-201?” www.econ.washington.edu/news/millimansl.pdf

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

16. But the Job Market Is Still Lagging For comparable data: www.minneapolisfed.org/publications_papers/studies/recession_perspective/index.cfm

17. 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

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

19. Recession Added Unemployment & Income Cuts on Top of Wealth Losses Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession." www.newyorkfed.org/research/staff_reports/sr482.html

20. Mortgage Problems High, Esp. for Young Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession." www.newyorkfed.org/research/staff_reports/sr482.html

21. Mortgage Debt Problems Are High in WI% of Active Loans 90+ Days Delinquent or in Foreclosure(Source: Lender Processing Services Applied Analytics) Seehttp://data.newyorkfed.org/creditconditions/

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

23. Finding a Job Has Taken a Lot Longer Source: www.bls.gov/opub/ils/pdf/opbils89.pdf

24. 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

25. Many Families Were Financially Stressed(unemployed, neg. equity, 2+ arrears on mortgage, or in foreclosure) Source: Hurd and Rohwedder, “Effects of the Financial Crisis and Great Recession on American Households.” NBER WP 16407

26. Budgets Often Stressed or Vulnerable Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

27. Overall, Losses Led to More Savings Note: Annual averages shown. For April 2011, the savings rate was 4.9%

28. On Average, Families Cut Food and Out-of-Pocket Health Care Spending Source: Hurd and Rohwedder, “Effects of the Financial Crisis and Great Recession on American Households.” NBER WP 16407

29. Stressed HHs Cut Spending More Deeply Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession." www.newyorkfed.org/research/staff_reports/sr482.html

30. Unemployed Reduced Savings Too(Where respondent or spouse unemployed, May ‘09 to April ‘10) Source: Hurd and Rohwedder, “Effects of the Financial Crisis and Great Recession on American Households.” NBER WP 16407

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

32. 1 in 13 Wisconsonites Took a Hardship Withdrawal (mid ‘08 to mid ‘09) Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

33. 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

34. Many Households Want To Act Prudently (Intended Response to Abnormal Income) Response to 1-Yr. 10 % Increase Resp)onse to 1-Yr. 10% Decrease Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession.“ www.newyorkfed.org/research/staff_reports/sr482.htm

35. Many Households Know Why To Save(Households’ “Very Important” Reasons to Save) Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession.“ www.newyorkfed.org/research/staff_reports/sr482.htm

36. But Many Report Reasons to Cut Savings (% listing reason as moderately or very important, Nov. 2009) Chakrabarti, et al., "Household Debt and Saving during the 2007 Recession.“ www.newyorkfed.org/research/staff_reports/sr482.htm

37. Few Are Happy with Where They Stand(Wisconsonites’ Satisfaction with Their Financial Condition, 2009) Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

38. (Financial Obligations and Key Components, as % of Disp. Income) Households Have Reduced Debt Source: Federal Reserve Board -- www.federalreserve.gov/releases/housedebt/default.htm

39. HH Delinquency Still High but Falling Source: www.newyorkfed.org/creditconditions/

40. Issues w. Credit Card Debt Common(mid 2008 to mid 2009) Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

41. Many High and Low Credit Scores in WI Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

42. Lack of Credit Self-Knowledge Accompanies Significant Income Risk Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

43. Savings and Planning Fall Short Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

44. Insurance Gaps – It’s Not Just Health(households w/o insurance, by type) Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

45. About 1 in 30 Wisconsonites Unbanked(among those whose responded) Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

46. Use of Alt. Financial Services Goes Beyond the Unbanked (mid ‘04 to mid ‘09) Source: FINRA Financial Capability Study, www.finrafoundation.org/programs/p123306

47. 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

48. Federal Reserve Resources www.federalreserve.gov/communitydev/default.htm, and www.federalreserve.gov/consumerinfo/foreclosure.htm