The Balance Sheet Challenge

1. The Balance Sheet Challenge Ray Boshara Senior Advisor, Federal Reserve Bank of St. Louis November 2011

2. Household Financial Stability • Families improve their financial stability through broad-based economic growth, higher net household incomes and, especially, stronger balance sheets. • Financially stable families face less economic risk and more economic mobility within and across generations. • Financially healthy families spend, save, and invest more, and thus contribute to economic growth. “Our overall economic stability relies ultimately on the collective financial health of all American households.” - Fed Governor Raskin, June 2011

3. What Makes This Moment Unique? • Continued slow growth and persistent unemployment, reflecting a deeper question: “What replaces the American consumer as the engine of economic growth?” • Financial insecurity severe among the poor and non-whites, and growing well into middle class. • Dodd-Frank, the Presidential campaign, mounting budget deficits, and rapid changes in the landscape of financial services.

4. Balance Sheets: Looking Back • Looking back, we have seen the damage to families, communities and the broader economy when we, as a nation, were not sufficiently attuned to the balance sheets issues affecting American households: • Wealth-depleting financial services • Low levels of savings • High levels and risky types of consumer and mortgage debt • Household assets not diversified beyond housing • Weak balance sheets contributed significantly to the financial crisis and economic downturn of the last few years: • 65% of the 6.2 million jobs lost between March 2007-March 2009 are due to household “deleveraging”—families needing to reduce their debts and rebuild their savings (Mian and Sufi, 2011).

5. Balance Sheets: Now • Weak balance sheets remain at the core of our economic downturn: • “Today, the headline problems are sovereigns in most advanced nations, banks in Europe, and households in the U.S…the fundamental problem is that weak growth and weak balance sheets – of governments, financial institutions, and households – are feeding negatively upon one another.” -Christine Lagarde, Managing Director, IMF, August 2011 • “Addressing over-indebtedness, private as well as public, is the key to building a solid foundation for high, balanced real growth and a stable financial system. That means driving up private saving and taking substantial action now to reduce deficits in the countries that were at the core of the crisis.” - Bank for International Settlements, June 2011 • While balance sheets have improved somewhat in the last couple of years, the financial health of American households remains weak: • Three-fifths or more of families across all income groups, according to the 2009 Survey of Consumer Finances (SCF) of the Federal Reserve, reported a decline in wealth between 2007 and 2009, and the typical household lost nearly one-fifth of its wealth, regardless of income group. • The Pew Research Center finds that, in 2009, typical net worth stood at $5,677 for blacks, $6,325 for Hispanics, and $113,149 for whites. About a third of black and Hispanic households had zero or negative net worth that year, compared with 15% of white households. • Almost half of all households surveyed in the 2009 Survey of Consumer Finances had less than $3,000 in liquid savings, and 20% had less than $3,000 in broader savings. Nearly half of all Americans consider themselves financially fragile, reporting that they are “certainly” or “probably” unable to come up with $2,000 from any source in 30 days (Lusardi, Schneider, and Tufano, 2011).

6. Balance Sheets: Looking Ahead • Families with strong balance sheets, especially assets, are more economically secure and upwardly mobile, and experience better social, educational, health, child and other outcomes. • Families with healthy balance sheets spend, save and invest more, and thus contribute to economic growth. • We will proactively research and help rebuild household balance sheets, in four ways: • As a conceptual framework, adding coherence and power to existing and future research and analysis. • As a barometer of the financial health of struggling families and communities, which now includes the middle class. • As a way to develop, not just protect, families. • As more conspicuous contributors to economic growth, better connecting the health of communities to the health of the broader economy.

7. Debt and Deleveraging • The household debt-to-income and household debt-to-assets ratios reached their highest points since 1950, with the debt-to-income ratio skyrocketing from 2001 to 2007 by more than it had in the prior 45 years. From 2001-2007, household debt doubled from $7 trillion to $14 trillion (Mian and Sufi, 2011) . • Roughly three-quarters of total debt is mortgage debt, and nearly one-quarter of homeowners have negative equity. • Consumer debt has become one of the most common shared qualities of middle-class America—usurping the fraction of the population that owns their home, is married, has graduated from college, or attends church regularly (Porter, 2011). • If incomes rise enough, households can build up their savings, reduce their debts and continue to consume. Deleveraging absent income growth is harmful to the economy: every percentage point increase in the savings rate reduces consumer spending by more than $100 billion (The McKinsey Quarterly, March 2009).

8. Household Debt to Income Ratios 1970s - Today 2x

9. Rebuilding Balance Sheets • Improve access to wealth-building financial services. • Generate savings, especially unrestricted savings and savings that lead to productive assets. • Reduce consumer and mortgage debts. • Use savings and “good” debt to secure a diversity of assets. Consider a family’s entire balance sheet.

10. Balance Sheets: Some Surprising Findings(See “Seven Surprising Findings,” Boshara, 2011) • Everyone, regardless of income, can save if they have access to a structured savings opportunity. • Unrestricted, emergency and precautionary savings matter more than we anticipated. • Match caps, in contrast to match rates, matter more in predicting savings. But matching deposits help families accumulate assets faster, and are equitable in light of asset subsidies for the non-poor. • Many “asset effects” were stronger than we anticipated. Even small amounts of assets, and sometimes simple account ownership, can generate large asset effects. • Financial education matters, but defaults and automatic features may matter more. Also, financial capability may be the result, instead of the source, of regular saving. • Some of our largest success, in terms of generating large amounts of new savings by LMI families, required no new government funding. • Asset building is still the right idea, even after the financial crisis and economic downturn.

11. “Asset Effects” - Research Findings • Dalton (2009) finds that while race, income, job status and net worth all tend to vary hand-in-hand, careful statistical parsing shows that it is really net worth that drives opportunity for the next generation. • Cooper and Luengo-Prado (2009) found that among adults who were in the bottom income quartile from 1984–1989, 34 percent left the bottom by 2003-2005 if their initial savings were low, compared with 55 percent who left the bottom if their initial savings were high—that is, 21 percent more adults moved out of the bottom quartile because they had higher savings. • Butler, Beach, and Winfree (2008) found that financial capital, along with family structure and educational attainment, are the three strongest predictors of economic mobility in America. • Cooper and Luengo-Prado (2009) found that children of low-saving, low-income parents are significantly less likely to be upwardly mobile than children of high-saving, low-income parents. • Elliot and Beverly (2010) discovered that, remarkably, youth with any kind of a bank account, as long as the account was in the youth’s name, are seven times more likely to attend college than those lacking accounts. • Shapiro (2004), combining data analysis and in-person interviews with a demographically wide range of families, found that the presence of even small amounts of wealth at the right times can have a “transformative” effect on the life course.

12. Rebuilding Balance Sheets: Ideas for Moving Forward • Tackle mortgage debt, and consider paths to responsible homeownership • Generate unrestricted savings • Leverage key moments in the life-course • Leverage technology and behavioral economics • Build assets as early in life as possible