This article first appeared in the St. Louis Beacon, Feb. 4, 2013 - As the U.S. economy continues its post-recession dawdling, economists at the St. Louis Federal Reserve believe that answers can be found in the weak balance sheets of American households still suffering from the aftereffects of the housing bust.
Although the Great Recession officially ended in June 2009, they point to some gloomy facts to explain why recovery has been so slow for many families:
- The median net worth of American households declined nearly 40 percent between 2007 and 2010, according to the Survey of Consumer Finances conducted by the Federal Reserve. Only about two-fifths of that loss had been recovered by early 2012.
- Every segment of the population lost wealth during the recession, but households headed by Americans under age 40 were particularly hard hit.
- Nearly half of the U.S. households surveyed in 2009 reported less than $3,000 in liquid savings. The lack of savings hasn't improved. According to a just released study by the Corporation for Enterprise Development, nearly 44 percent of Americans don't have enough savings or other liquid assets to stay out of poverty for more than three months should they lose their jobs, face a health crisis or some other income-depleting emergency.
Economist Bill Emmons and policy analyst Ray Boshara, who lead a research department on household financial stability at the St. Louis Fed, say it’s not enough to focus on what U.S. households are earning. It’s also important to understand what they save, own and owe. Their research has shown, for example, that economic recovery has been hardest on those many American families who were not only carrying heavy loads of debt going into the recession but had put their financial eggs into one basket: real estate.
"Household balance sheets have been relatively understudied but are increasingly recognized as important for both the stability and mobility of families -- but also for the growth of the nation,’’ Boshara said.
"Debt was the real story of the last several years, and if you don’t tell the debt story and understand debt better you don’t really understand what’s going on. One of the things that we believe is holding back the recovery is weak balance sheets,’’ he said.
To further this research, the St. Louis Fed and the Center for Social Development at Washington University, will host a symposium this week titled "Restoring Household Financial Stability after the Great Recession: Why Household Balance Sheets Matter.” They’ve invited national financial experts and academics to share research on Americans' household finances and to discuss ways to improve those balance sheets and prevent such sweeping losses in the future. Keynote speakers include Michael Barr, former assistant secretary for financial institutions at the U.S. Treasury Department and Jeremy Stein, a member of the board of governors of the U.S. Federal Reserve.
Chasm between Wall Street and Main Street
While it might seem obvious that households hard hit by unemployment and depressed house prices are still in trouble, Boshara and Emmons point out that economists usually focus on the big picture -- the macroeconomics.
For that matter, so do most Americans. And at first brush, the economic picture painted by the daily business report has been rosier in recent weeks:
- The national unemployment rate continues to hover below 8 percent, down from a high of 10 percent in October 2009.
- The stock market has rebounded to pre-recession levels.
- Even housing prices are starting to rise.
But despite those positives, the U.S. economy contracted in the fourth quarter of 2012, for the first time since the second quarter of 2009 -- when the recession was still officially on.
Boshara and Emmons don’t speak for the Fed, but they hope that taking a closer look at household finances might prod economists to think beyond conventional wisdom and to consider new solutions.
Before the crisis, the conventional wisdom among policymakers and most economists was that the financial sectors were self-regulating, Emmons said.
"Certain markets might go up, they might go down. That’s just the way the system works,” he said.
According to that conventional wisdom, Emmons explained, a spike in mortgage defaults would cause concentrated pain among those who were affected, but the economy’s natural mechanisms would adjust. Defaults would drive house prices down, and the lower prices would induce other people to step in and buy the houses. In the case of a greater shock to the housing market -- one that affects the economy as a whole -- the bigger equilibrating mechanism is interest rates.
"There would be lots of churning going on, but from the macroeconomic perspective -- the aggregate perspective -- it all sort of takes care of itself. That was the reigning orthodoxy before the crisis,’’ Emmons said.
But after the financial crisis of 2008, the adjustment mechanisms haven’t been sufficient or able to keep up with the scale of adjustment that’s going on, he said.
"We’ve got this colossal decline in house prices, and it still hasn’t induced enough new buying to put life back into the housing market,’’ Emmons said. "And you have these huge balance sheet problems -- defaults and deleveraging going on -- and the interest rate can’t fall low enough to induce other parties to step in. When the history is written of this episode, the debate will be whether we should have anticipated that the shock could be so big that it essentially overwhelmed the natural adjustment mechanisms or whether in fact we need to worry about this quite a bit in the future.”
Emmons noted that the historic nature of the recession -- the deepest in decades -- caused a shock that was so big no one could have reasonably anticipated the scale of it.
"That having been said, we are now in a situation where what we thought was the natural adjustment mechanisms have been overwhelmed,’’ Emmons said. "We’re in a position where we don’t quite know what tools to use and how to use them. I think it’s a period of confusion.’’
Is it time for rethinking?
Boshara said the research on household finances is showing that the traditional focus on education, jobs and income levels doesn’t take into account other factors necessary for financial stability and mobility.
"Even if you have a reasonable income, if you don’t have enough savings you’re not going to be able to prevent moving backward -- falling down the economic ladder -- as well as being able to make investments for moving forward,’’ he said.
Emmons and Boshara say that understanding finance at the household level is vital because consumer spending drives the U.S. economy.
"The consumer still is pulling the economy, and of course that is made possible partly because the rest of the economy is so weak but also because of the massive government support through lower taxes and higher spending,’’ Emmons said. “That’s the source of the budget problem. I’m in the camp -- and have been for a few years -- saying this can’t go on.’’
Boshara said there is another, deeper problem.
"We’re not quite sure what replaces the American consumer as the engine of economic growth,’’ he said. “So I think this malaise you’re seeing -- this stagnation, the sputters -- all reflect this deeper question that we haven’t really sorted out. What comes next? There has to be renewed attention to the balance sheet. It’s critical to getting the economy going again, but other measures are going to be necessary, as well.’’
Their research has also provided additional insights into the financial pain of the recession, and it is in many ways a generational story. While older Americans lost the most in absolute dollars, younger Americans lost larger percentages of their wealth.
"After a war or depression or other sort of national trauma, it takes younger people to rejuvenate (the economy), and that’s one thing that is most disturbing. Younger families were really hammered by this downturn,’’ Emmons said.
Related research:
* "Why did young households lose so much wealth during the crash? The role of homeownership” by Fed economists Bill Emmons and Bryan Noeth
* "Mortgage borrowing: The boom and bust” from the January 2013 Regional Economist by Fed economists Bill Emmons and Bryan Noeth
* "No Slack: The Financial Lives of Low-Income Americans,” a book by Michael S. Barr (Brookings Institution Press). Barr served as an assistant secretary in the U.S. Department of the Treasury and helped draft the Dodd-Frank Wall Street Reform and Consumer Protection Act.
He recognizes that there are no easy solutions and that any discussion of programs to relieve debt quickly hit political walls.
Emmons points to the Troubled Asset Relief Program (TARP) -- popularly known as the bank bailout -- that Congress approved in October 2008 as U.S. financial institutions teetered on financial collapse.
"That was supposed to be a one-time deal recognizing that this was a systemic crisis, and we needed to deal with the debt quickly and recapitalize these institutions because they are so critical,’’ Emmons said. “In the TARP, there was a $50 billion piece that was dedicated to homeowners and only something on the order of $3 (billion) or $4 billion has ever been spent because it quickly ran into political headwinds.’’
While the original intent was to provide relief for homeowners, paralleling the relief provided by taxpayers to banks, the bailout for homeowners who had borrowed too much met with such opposition it was stopped in its tracks.
"That didn’t happen, and we’re now stuck with all this debt and forcing individuals to try and work through it,’’ he said. “Many can’t -- and that’s where all the defaults are coming from.’’
While most of corporate America has gotten past its debt problems, many American households are still mired in money woes.
"From traditional metrics, stock prices look pretty reasonable. Profits are very good,’’ Emmons said. “Within the household sector, the people who were struggling with the overhang of debt are drowning and yet there are others who are in great shape because they kept their jobs and maybe picked up stocks when they were low and those have doubled.’’
In that respect, the housing bubble and crash and the way recovery is playing out has reinforced a long-term trend toward wealth disparity, he said.
"The strong going in are even stronger coming out, and the weak going in are even weaker coming out. And part of that was the way housing was oversold to people to in part make up that wealth gap,’’ he said.
The sustainability of U.S. homeownership and the impact of the housing bust on household balance sheets will be among the topics discussed at the symposium. Other issues will include: loans and college outcomes, retirement security, assets poverty and the growth of the overall economy.
