Personal Finances, the Great Recession and the Sluggish Recovery

We all keep wishing the economy would "feel better", don't we? that there could be a sense of greater confidence in jobs, in opportunities, in everyone's financial situations.  We wonder why the recovery from the recent Great Recession could be taking so very long.

Our last look at the economy, posted in late June, focused on the job market, and we promised then to talk again about possible reasons the current malaise has resulted in people dropping out of the labor force.   Very soon, the Census Bureau and the Labor Department will publish some detailed data for 2013 that hopefully will help us tackle that question.

Meantime, there is one area we can speak to, the condition of personal finances, a topic for which we already have a quantity of recent information.  One of the main causes of the Great Recession was that people borrowed lots and lots of money.  Much of the public commentary about that recession asserts that financial speculation and bankers brought on the crisis.  Clearly they were important, but it's also true that people took on more and more debt.  Bankers and traders did speculative things with that debt, but it all did start with the consumers who borrowed the money.  A key, then, to the resumption of stronger growth is likely related to the progress people are making in correcting this over-reaching.

Mortgages & Homeowners' Negative Equity

Mortgage debt expanded sharply from the middle of 2001 through 2006, over 13% a year.  The payments on that debt, so-called "debt service", surged from 5.9% of people's disposable income in 2004 to 7.2% at the end of 2007.  People who refinanced mortgages borrowed more than their existing liability during those years, decreasing the equity they had in their homes.  Overall, this home equity withdrawal amounted to almost $500 billion a year from 2003 to 2006.[1]

As people were stretching their personal financial conditions, interest rates began to rise in 2004 and people with adjustable rate mortgages or initially low "teaser" rates saw their mortgage payments go up sharply.  By late 2006, unusual numbers of borrowers started having trouble keeping current on their payments on those and regular mortgages as well.  The greater delinquencies hurt the lenders and the owners of bonds backed by the mortgages.  The climb in home sales peaked in 2005, and they began to decline.  Home prices started to fall in 2006; although those have finally begun to climb again, they remain well below their 2005/06 highs.  The result, even now, is that 17% of homeowners have a mortgage that is larger than the value of their home.[2]  Called "negative equity", that's actually an improvement from over 25% in early 2013 and almost 31% in mid-2012, but remains a heavy weight on people's approach to spending and their outlook on the economy in general.

Even now, after some recovery, housing and mortgage activity remain in the doldrums.  New home construction this year is running no more than half the pace of 2005, and sales of existing homes are still down some 30% from that year's pace.  The latest weekly report from the Mortgage Bankers Association shows a new recovery low last week in the volume of mortgage applications.  People are still staying back from mortgage debt.

Credit Card Debt Got Big Too

Another consumer debt issue is credit cards.  From the spring of 2006 through early 2008, credit card balances accelerated; from very modest growth of about 2% year-over-year in early 2006, they were expanding at a 10% rate by late 2007.

Average credit card balances reached what are, to us, astounding levels:  in 2007, households in the middle 20% income bracket owed $6,300 and those in the next rung down, $4,900.  Balances were higher, of course, in higher brackets, so the average over the entire income span was $8,200.[3]  If these were charged interest at a common credit card rate of 1-1/2% a month, the interest add-on each month would have been $120!  Delinquency rates on credit cards in those years hovered around 9% and rose rapidly during the recession; they reached 13.74% by the spring of 2010.[4]

Credit card usage did slow.  By last year, the middle income bracket's average had fallen to just $4,900 and the overall average to $5,700, this latter a reduction of 35% from its peak.  People are paying larger portions of their bills each month too; from 19% of their balance each month in 2006, people in recent months have been paying almost 25%.[5]  The lower balances have obviously accompanied more sluggish spending growth.  In the 2004-2007 period of big increases in credit card balances, spending was expanding at rates of 6 and 7% a year.  It declined outright in 2009 and has had a modest, uneven pattern since then.  In 2013, people increased their outlays on categories of items that might be charged to a card by just 3% and this year's second quarter was up 3.6% from a year earlier, half the pace during the "spree".[6]

There are numerous reasons for the currently mediocre performance of the U.S. economy, and one of them is surely this restraint on credit use.  Some of this might be banks turning down applications, but as we note with the mortgage information, people are not even applying in much volume in the first place.  In view of the excess of the 2004-2007 period, this caution is quite appropriate.   Importantly, it is helping to improve credit quality; credit card delinquencies in the second quarter were back down to 2.25%, and those on mortgages are down from a peak of 8.9% in early 2010 to 3.4% in the latest period.

The better delinquency situation is laying the groundwork for renewed spending growth on a much sounder basis.  Recent retail sales reports suggest this might be happening.  Also, we do note that people are buying cars these days and obviously borrowing to do that.  After a long hiatus, many people's cars and SUVs have simply grown old and need replacing, so it is not surprising to see this.  It is the only category of ordinary consumer borrowing with much vigor.

People May Still Not Be Saving Enough.  Are You?

At the same time, there are two issues still to grapple with: student loans and saving.  Student loans are a whole topic on their own and we will return to talk about them and the "worth" of incurring big, long-term debt to pay for college.  Saving has improved since the Crash and recession, but continues as a matter of concern.

The saving rate, that is, the amount of personal income not spent, got as low as 2% during the debt-spree years, reached a band of 6-7% in 2011 and 2012 and recently was 5.3% in the second quarter.[7]  So it's clearly up off the lows, but not "high".  Also what isn't "high" is the number of people who actually have a cautionary stash of emergency cash under their mattress (or in a safe bank account somewhere) .  A special Federal Reserve survey of people's economic well-being taken during 2013 asked them about this:  "Have you set aside emergency or rainy day funds that would cover your expenses for 3 months?"  Only 39% of participants said yes.   Further, younger people have a lower positive response: only 33% of households headed by 18-44 year-old people said yes.  There is no history of this for comparison, so we don't know how low that number would have been during the spending-spree era.[8]

So we are not surprised that the economy remains relatively sluggish; we believe some of this reflects the extension of a rebuilding effort for people's own financial standing.  There are lots of other issues, but that is certainly one that had not impacted previous business cycles so deeply or pervasively.  We've illustrated some progress, though, and look forward to further improvement.  Meantime, stick a little cash under your mattress every paycheck until you think you can cover three months' worth of expenses!

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A new book, published just in May, encouraged us to give these ideas some extra emphasis.  House of Debt, by Atif Mian and Amir Sufi, explores mortgage borrowing by zip code around the country, highlighting the role of the debt itself in generating the severe recessionary conditions throughout the economy, not just in the housing sector.  The book's subtitle is "How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again."  Hmmm. 

We also consulted Stephan Whitaker's "The Evolution of Household Leverage during the Recovery", an Economic Commentary of the Federal Reserve Bank of Cleveland, dated September 2, 2014.  Whitaker has calculated household debt/income ratios for census tracts around the country.  http://www.clevelandfed.org/research/commentary/2014/2014-17.cfm

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Footnotes cover specific data sources.  Most of our actual data references come from these sources as presented in the databases of Haver Analytics.

[1] Federal Reserve Board, Financial Accounts of the U.S.  Equity withdrawal amounts are taken from calculations made by Haver using those Federal Reserve data.

[2] Zillow, Inc. "U.S. Negative Equity Falls to 17 Percent", Press Release, August 26, 2014.  http://zillow.mediaroom.com/2014-08-26-U-S-Negative-Equity-Falls-to-17-Percent.

[3] Federal Reserve Board.  2013 Survey of Consumer Finances.  Issued September 4, 2014.  http://www.federalreserve.gov/econresdata/scf/scfindex.htm

[4] Federal Reserve Bank of New York.  Household Debt and Credit Report.  2^nd Quarter 2014, August 14, 2014.  http://www.newyorkfed.org/microeconomics/hhdc.html#/2014/q2

[5] Payment rates on credit cards from the Standard & Poor's Ratings Services' U.S. Credit Card Quality Index (CCQI).

[6] Data on consumer spending from the Department of Commerce, Bureau of Economic Analysis (BEA), in the "national income accounts", that is, the same dataset as GDP and its other components.  We calculated a "credit card spending subtotal" by taking total consumer spending and subtracting off housing services, education, health care, vehicle purchases and other broad spending categories that aren't likely to be paid for by charging to a credit card.

[7] The saving rate is also taken from the BEA's national income accounts.

[8] Federal Reserve Board.  Report on the Economic Well-Being of U.S. Households in 2013.  "Savings Behavior", pp. 17-18.  July 2014.  http://www.federalreserve.gov/econresdata/2014-economic-well-being-of-us-households-in-2013-household-economic-wellbeing.htm