Rebuilding Family Balance Sheets, Rebuilding the Economy: How Demographics Drive Household Balance Sheets

May 22, 2013

With reduced wealth and income, many families found themselves with too much debt, Bill Emmons explains. Some voluntarily reduced their debt by paying off principal balances faster than scheduled and by avoiding or reducing new borrowing. Many also underwent involuntary deleveraging—not being able to borrow as much as desired or defaulting on existing debt. Both deleveraging methods slowed economic growth. In addition, Emmons explains how the demographics of age, educational attainment, and race or ethnicity are primary drivers of household balance sheets. He shows how the hardest hit groups were families that were young, less-educated and were members of historically disadvantaged minorities.

Presentation (PDF)


William Emmons: Okay, so a balance sheet has two sides, and I'm going to show you a balance sheet in just a second. A balance sheet has the asset side. That's what I'm talking about here—huge declines in asset values. There's also a liability side of a balance sheet. And we think that that's really important to understand what has happened in the last couple of years. There is a very pronounced trend toward households reducing their debt, what sometimes is called deleveraging. So we're calling this phase two of the balance-sheet recession.

We're getting a very, very sluggish recovery from this downturn. So it makes sense if someone—if a family sees their wealth has gone down—maybe their income has gone down, maybe they've lost a job or their hours have been cut—they may find themselves with too much debt. What they thought might have been appropriate before the downturn no longer feels appropriate. And so how do people deal with that? We can think about it really in two ways.

You can reduce debt voluntarily, and by that we mean paying down your mortgage principal faster than you otherwise would, maybe making extra payments, maybe refinancing into a shorter term where the amortization is faster, that reduces the principal faster. Or you could avoid new borrowing or reduce the amount that you borrow, relative to what you might have done before the crash. So we can think about that as voluntary, but it still has this effect on the economy of slowing down spending, slowing the growth overall.

There's also, of course, involuntary deleveraging. By that, I mean that maybe the lender says they're not going to make a loan to you. You can't refinance. Maybe you don't have enough equity in your house. Maybe your income isn't good enough. Maybe their standards have changed, tightened up since before. And, of course, finally, the thing that really gets the most coverage is people defaulting on their debts.

That also has the effect of reducing debt on the balance sheet, but typically, for example in a home foreclosure or defaulting on a car loan, you also lose some very valuable collateral at the same time. So this is certainly not a painless way to get rid of debt. But, however, it's happening, and we have evidence that all of these things are going on. This reduction of debt, the deleveraging, does have the effect of slowing down the economy, because people are putting resources into paying down debt that would otherwise be going into spending.

So, again, the overall picture of the economy is the red line there. The blue line in this picture is the total amount of debt that households have, adjusted for inflation on an average household basis. And of course, the first thing that jumps off the page is the incredible increase in debt before the downturn. And it peaked in about 2008 right there. And since that time, since the severe financial crisis when the economy started to stabilize in 2009, you can see, I think, that this was a very weak recovery.

So we're just not making up that lost ground very fast at all. And, again, the timing suggests that this period when households are voluntarily and involuntarily reducing their debt is precisely the time period—it overlaps with this very, very weak recovery. So it's at least some evidence that that's why the recovery is so weak. So many families are reducing their debt.

And so in some we think both the loss of wealth and the deleveraging that's happened in the aftermath are why this is—it's appropriate to call this a balance-sheet recession. These effects have always, of course, been present to some degree, but not in our memory, at least not in our living memory, to this degree that it has affected so many people in so many different parts of the country.

So with that as backdrop, hopefully you're convinced now that this actually matters for the overall economy. It matters for everyone. Even if you maybe in one of those questions considered your own financial situation to be pretty good, the fact is we're all affected by this, because there are so many families that have been hit so hard, recovering so slowly, and it's all, of course, connected. It all feeds back. So we think it matters a great deal.

Let's now look a little bit more closely at what's actually going on with different groups of families. Now this work is going to be based on Federal Reserve survey data, called the Survey of Consumer Finances. It in its current form began in 1989. The survey is taken every three years. The most recent one was in 2010 with about 6,500 families.

And so what we're going to do to organize the data are to look along three different dimensions, demographic dimensions. Age we think is very important, so we're going to look at young, middle-aged and older families. We're going to look at educational attainment. And, again, we'll cut it into three pieces—families whose family head did not finish high school, those with a high school degree, or those that have a college degree, two- or four-year degree.

And, finally, another dimension that is important is race or ethnicity. And we're going to cut the population into two pieces, one, what we're calling historically disadvantaged minorities—African-Americans and Hispanics that may have faced discrimination in housing markets, credit markets sometime in the past or even in the present, but the legacies of those acts of discrimination still have consequence today. The other group is white or Asian families.

So with that as background, let's look at a balance sheet. So we're going to simplify a family's balance sheet. On the asset side we're going to look at durable goods, for example, automobiles, boats, whatever it might be. Second category, financial and business assets. So these are stocks and bonds and deposits, mutual funds, or a small business that you might own, and finally, residential real estate.

Our intuition was—and I think it's been confirmed by the data—is that housing played an absolutely first-order role in this cycle. So we want to really be able to focus on the role of housing on people's balance sheets.

On the liability side, we're just going to split all debts into those that are secured by residential real estate, mortgage debt, versus everything else. And that includes credit card debt, auto loans, student loans, anything else that's a liability. And, of course, the difference between assets and liabilities is net worth, and it could be positive and it could be negative. In fact, there are a substantial number of families who have negative net worth, where their liabilities exceed their assets.

So, first, before I give you some specific numbers, just let me show you some trends. So I'm going to show you some groups of families, organized in that way that I described, that have done pretty well over the last couple of decades, and in fact have recovered pretty well since the downturn. So the data here run from 1989 to 2010. Those are each Survey of Consumer Finances numbers.

And then the last observation is an estimate that Bryan Noeth, who is here, is part of our team, and I have worked on to try to estimate what would these numbers be if we could get that survey data. So we've combined some other data sources to estimate those amounts. So the top line here is middle-aged—that is 40 to 61 years old— white or Asian college graduates. So this is the average net worth—and these are adjusted for inflation—for that group of families observed at each of these survey dates.

And so the longer-term trend, of course, is up. This group as a whole has seen a substantial increase in net worth over time. And what's I think also very important is that in the latest segment of this line there's been a substantial recovery since 2010. And you say, "Well, how could that be? The housing market is still very weak." Yes, but the stock market has recovered very strongly. And this is a group that has a very substantial interest in the stock market.

The second group down is older white or Asian college graduates. So these are 62 and over. Similar kind of pattern. A substantial increase in net worth over time. Somewhat of a recovery since the 2010 observation. And then the third group here is older black or Hispanic college graduates. And, again, very similar. Longer-term, especially since, say, 1992, a very substantial increase in wealth over the years and a noticeable recovery since 2010.

Now let's look at some families that haven't done as well. So these are middle-aged and younger families. So the line that goes off the chart and then comes screeching back down is in fact this third group. These are young—that means under 40—black or Hispanic college graduates. So we saw a huge increase in wealth in the 2000s very much tied with the housing boom and then a huge decline. And notice that even in the latest period, our estimate is that it has continued to decline because housing markets have continued to be so weak in many parts of the country.

The red line here is the middle-aged white or Asian high school graduates. Not much change over the long period, and in fact, you can see over the entire period essentially unchanged. There's been no net increase in net worth in this group. And then the third one is young white or Asian high school graduates. Again, not much recovery. And for all three of these groups, notice that the levels that we estimate for 2012 are actually below the levels of 1989. So the average wealth of these groups has declined since 1989 over more than a two-decade period.

So we believe this provides some evidence—and we've looked in great detail at the demographics and how that relates to portfolio compositions and the results that different groups have experienced during this downturn. So, as I said, we're looking at young, middle-aged, and older families. We're looking at people with less than a high school education, high school grads, and college grads, and historically disadvantaged minorities versus whites and Asians are the primary components of that group.

So every single family falls uniquely into one of these 18 cells at every observation point, and we're tracking that over time. So what we find during this downturn and the subsequent overall weak recovery is that the hardest-hit groups in—I would say in this order of importance—were young families, less-educated families, and those from historically disadvantaged minorities.

Why? Why are these groups so much affected by the downturn? Well, these are all groups that had—this was true historically, and it was true again during this recession—high vulnerability to job loss, either because, being young, you have less experience on the job, so maybe you were the first one to be laid off.

It's also the case that less-educated people tend to be in more cyclical industries like construction, which was very much affected by the downturn. And it could be other characteristics of jobs that make people in these groups more vulnerable to losing a job. And it happened again this time.

We also find evidence that these groups have low savings rates compared to other groups. They hold very few liquid assets, so they're very close to an emergency, a financial emergency, if something happens. These are, in fact, precisely the groups that we know are using high-cost financial services outside the banking mainstream, which also tends to undermine financial strength.

We also find—and I'll show you some evidence of this—very high portfolio concentrations in housing. So, in fact, when house prices decline it has a much bigger effect on these groups. And these are the same groups that have very high debt ratios, associated often with the housing decision.

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