After the Fall: Rebuilding Family Balance Sheets, Rebuilding the Economy

2012 Annual Report Header

In our annual report, you will learn about our work, our people, our mission and our results. As in the past, we also feature an essay on a timely topic that is central to America's economy. This year's essay focuses on the need to rebuild household balance sheets in the wake of the financial crisis, a need that is important not only for families but for the economy overall. The co-authors are the director and chief economist for the St. Louis Fed's new Center for Household Financial Stability.

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The financial crisis and Great Recession have had profound effects not only on the US economy as a whole, but on individual households. The collapse of the housing bubble left households with much more debt relative to their incomes and wealth than they would have expected otherwise. It is important to learn about the impact of household balance sheets on the overall performance of the US economy. It is also important to understand the role that household balance sheets play in the stability and upward mobility of families.

When we say the household balance sheet or the family balance sheet, we're talking about really four things. The quality of your financial services. Where do you bank? Do you go to the payday lender, the check casher, or do you go to a mainstream financial institution? Secondly, it's your savings, whether liquid savings or longer-term savings.

Third, it's your assets. What do you own? A home, a business, a retirement account. And fourth, it's your debts, whether they are mortgage debts, or consumer debts, or student loans, whatever they might be. The overall best measure of a household balance sheet is what's called your net worth, the difference between what you own and what you owe.

Until recently, there hasn't been much focus on household balance sheets. They were believed to be in decent shape on average. And if there were failures, there didn't seem to be evidence of harm to the overall economy. But this time was different. After the fall, enough families lost enough of their net worth that they cut spending dramatically. And that put the brakes on our consumer driven economy. In the end, economists started calling the Great Recession the balance sheet recession.

Total household wealth peaked in about 2007, and then declined something on the order of 15% on average between 2007 and 2010. The median measure of net worth went down 39%. It appears that the families hit hardest by the downturn financially were those who were younger, tended to have lower levels of education, and were historically disadvantaged minorities, African-Americans and Hispanics.

So the strongest groups financially in the population tend to be older, more highly educated, and white and Asian. Those families tend to have a more diversified balance sheet with housing wealth, but also financial assets, including stocks, bonds, and other bank deposits. Also, those families tend to have very little debt relative to the size of their assets. So they were more diversified, more able to benefit from the rebound in the stock market, and suffered much less in terms of exposure to defaults, foreclosures because they had very little debt.

Whether balance sheets are weak or strong has major significance at the micro level and at the macro level. At the micro level, we are talking about families.

One study shows that controlling for family's background, their education, their income, that it's really net worth that drives economic opportunity from one generation to the next. We also have evidence showing that healthy balance sheets have a lot to do with who goes to college and who actually completes college.

Even very small amounts of savings $1, $25, $50 can have a big impact, an enormous impact on whether or not somebody actually goes to college and finishes. We think that's because savings forms what's called a college bound identity. You think ahead and you're likely to engage in behavior now that affects the likelihood that you will attend college later on. When you think about college, it's not just the savings you have to look at. It's the debt too.

We also have evidence showing that families with high levels of unsecured debt are much less likely to graduate from college. One study found that if you look at two similar families both with college degrees, the family that has college loans outstanding, student loans outstanding has $185,000 less net worth than the family that has no student loans.

Student loans displace the acquisition of other productive assets. So you have less disposable income. Your credit scores are going to be lower, which means you have poor access or not as good access to wealth-building debt. And simply because of the lower less income to work with and the lower credit scores, you're not able to buy a home, to start a business and to save for retirement, which has a big effect on your balance sheet later in life.

Another way that balance sheets matter is in the stability of families. There's a study showing that families with liquid savings are two to three times less likely to experience material hardship after a death in the family, a job loss, or other sort of economic catastrophe.

Whether balance sheets are healthy is also important on a macro level, that is for the economy overall. And balance sheets haven't been healthy since the housing bubble burst. In just four years between 2005 and 2009, housing wealth declined about 35% adjusted for inflation. And that caused consumers to rein in their spending.

One study estimated that consumer spending ended up roughly $350 billion less than it would have been in 2010 had the bubble not burst. But consumer spending isn't falling just because assets like houses have lost value.

There also seems to be on the liability side of the balance sheet something very important that's going on. It's often summarized in terms of deleveraging. There are at least two ways you can think about deleveraging, that is reducing debt. One is people actually defaulting on debt. So that's foreclosures, consumer bankruptcies, as well as other defaults.

Those are damaging in the sense that the people who have defaulted are typically going to be cutting their spending. And it also typically involves lots of extra costs involved in, for example, the foreclosure process. So a lot of economic resources are being absorbed by this activity, which is not creating overall economic growth.

The other aspect of deleveraging is what you might call voluntary deleveraging. So somebody who say makes an extra mortgage payment, or refinances a longer term loan into a shorter term loan in order to pay down that debt faster. Well, that means that the family is devoting more of their resources to reducing that debt than they are to spending on other things.

And that spending on other things is needed to keep our economy growing. Historically, consumer spending has been about 70% of gross domestic product. During the decade preceding the crisis, it contributed 80% of total GDP growth. So where do we go from here? Although about 45% of the lost household wealth in inflation adjusted terms has been recovered since 2010, there's still a long way to go until we reach full recovery. The St. Louis Fed's New Center for Household Financial Stability aims to provide a framework for all of us to figure out where we go from here.

We have three questions that we hope to answer. One is, what is the state of the American balance sheet? What can we say about the overall health of American balance sheets? Second, why do they matter? Why do balance sheets matter for families, and why do they matter for economic growth? And third, what can we do about it? What can financial institutions, nonprofits, families, researchers and policymakers do to improve household balance sheets?

One of the things that we need to think about is the role of homeownership. For most American families, that is the largest asset on their balance sheet. And because of really the violence of the downturn in the housing market, it had profound consequences on millions and millions of families. So we don't have the answers, but we think this is the moment when we need to think about how homeownership fits in to the overall concept of having financially stable households.

For more on this topic, read the essay in the new annual report of the Federal Reserve Bank of St. Louis. To learn more about the Center for Household Financial Stability, see


Essay in English

Essay in Spanish

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