After joining the St. Louis Fed as a senior advisor in April 2011, Ray Boshara proposed coordinating a new research-based project on household financial stability, with an emphasis on rebuilding the balance sheets of struggling American households. Publications, symposia, a web-based clearinghouse, a “financial stability index,” and several outreach events in the Eighth District and nationwide are planned for 2012 and beyond. Boshara’s work caught the attention of the U.S. Senate Banking Committee, and he was invited to testify in October 2011 at a hearing entitled “Consumer Protection and Middle Class Wealth Building in an Age of Growing Household Debt.” An abridged version of Boshara’s testimony appears below; the full text is also available.
Chairman Brown, Ranking Member Corker and members of the Subcommittee, thank you for the invitation to appear before you today. My efforts to rebuild household balance sheets are focused on families hardest hit by the financial crisis and the economic downturn, those who have experienced significant losses of employment, income and wealth. We know that balance sheets matter because financially healthy families spend, save and invest more, and thereby contribute to economic growth.
Why Balance Sheets Are Important
Balance sheets, by which I mean the savings, assets and debts of households, merit attention for three reasons. First, over the past few years we have all seen the damage to families, communities and the broader economy derived from balance sheet challenges. For too many years, household debt levels rose, eventually to dangerous levels, while little was done to build up household savings and to diversify family assets beyond housing. When the housing bubble burst, the wealth of many households plunged, leaving balance sheets at historic lows. While balance sheets have improved somewhat in the last couple of years, financial instability remains severe among the poor and persons of color, and reaches well into the middle class.
Second, according to many economists and the International Monetary Fund, weak balance sheets have had negative “wealth effects” on the economy, meaning that households with lower levels of wealth consume less. That, in turn, harms the economy, which in turn further harms households, which further slows economic growth, and so on.
And third, a growing body of evidence shows that families with assets generally do better in life than those without, and that the earlier in life one has assets, the better he or she will do. For example, New York University’s Dalton Conley found that “it is really net worth that drives opportunity for the next generation.” William Elliott and Sandra Beverly discovered that 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—regardless of academic achievement. Other researchers have also found that small amounts of wealth at the right times can have a transformative effect on the life course.
Policy Ideas for Rebuilding Balance Sheets
For families, reducing their debts and rebuilding their savings—or “deleveraging”—is already, painfully and slowly, under way. Yet millions of families need to delever even more, including further measures to address the housing crisis. Roughly three-quarters of total household debt is mortgage debt, and nearly one-quarter of homeowners nationwide have negative equity. Resolving the housing crisis is beyond the scope of my expertise and testimony, but I would like to observe that, historically, homeownership has been an effective route to wealth accumulation for generations of families, including low- and moderate-income families. Accordingly, we should continue to study responsible paths to homeownership for those who are ready and qualified, balancing the risks and the rewards for families, investors, government and others.
With that said, let me offer five policy recommendations to help households rebuild their balance sheets.
First, as the evidence suggests, build assets as early in life as possible. Policies that automatically create a savings account at birth for every child born in America, with greater resources available for lower-wealth families, hold promise to expand opportunity and build a stronger middle class over time. Lower-cost alternatives, such as a “Kids’ Roth,” could be considered as well.
Second, save and reduce debts at tax time. Income tax refunds average nearly $3,000, including those received by low-income parents because of the Earned Income Tax Credit (EITC). Such refunds, and the broad reach of the tax system, offer good opportunities to repair or rebuild balance sheets. The IRS’ form 8888, which enables all taxpayers to deposit their refunds automatically in up to three separate accounts, holds particular promise in leveraging tax refunds into savings and debt reduction.
Third, accumulate assets at the workplace. The workplace has always been and remains a fulcrum for building savings and assets. In fact, the vast majority of pension wealth in the U.S. is structured through employers. To generate more employer-based savings, policymakers could consider proposals to set up automatic payroll deductions into retirement and unrestricted savings accounts managed by financial institutions outside the workplace, similar to the “AutoIRA” concept now being discussed in Washington.
Fourth, generate unrestricted savings, which can be used for emergencies or precautionary purposes—and which remain in very high demand by low- and moderate-income consumers. Families with sufficient levels of unrestricted savings are more likely to be banked, to pay down and secure better loans, and to acquire a longer-term asset such as higher education, a small business or a home.
And finally, consider supporting innovations to state-based 529 college savings plans and other ways to promote savings earmarked for college. Many studies have documented the role that a good education, especially completion of a postsecondary degree, has on one’s future earnings and wealth, and how the lack of an education and skills are among the strongest predictors of downward mobility.
As implied in the recommendations above, there is a great need to diversify the savings and assets of families, especially those below median income. As Federal Reserve Board Vice Chair Janet Yellen has said, “In light of this experience [with collapsing housing prices], it makes sense to think about the development of wealth-building vehicles for low- and moderate-income households that have some of the desirable qualities of homeownership as an investment, but perhaps have less of the risk. ... Although households will likely need to take on some risk in order to accumulate wealth, the risk should not have the potential to destroy a household’s financial security. Continued research in this area is badly needed.”
Mr. Chairman, I commend you for convening this hearing today. We know that household debt is both weighing down millions of families and stifling economic growth. Thankfully, we have compelling evidence, some of it presented here, suggesting that rebuilding balance sheets and net worth will help hard-hit families and the broader economy move forward. I hope to make a modest contribution to this critical challenge. Thank you.
Ray Boshara is a senior advisor at the Federal Reserve Bank of St. Louis. Previously, he served as vice president at the New America Foundation, a Washington, D.C.-based think tank, where he also founded the Asset Building Program.