William Emmons, Links Between Younger Americans' Balance Sheets and Economic Growth

May 8, 2014

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   James Bullard, Federal Reserve Bank of St. Louis (5:54)

Keynote Address

- Introduction
   Ray Boshara, Federal Reserve Bank of St. Louis (4:05)

- Keynote Address
   Neil Howe, Founding Partner and President, LifeCourse Associates and President, Saeculum Research (36:03)

   Keynote Q&A (11:04)

   Extended Interview with Keynote Speaker Neil Howe (28:43)

Plenary One — A Micro and Macro Look at Younger Americans' Balance Sheets

- The State of the Balance Sheets of Younger Americans
   Lisa Dettling, Board of Governors, Federal Reserve System (14:25)

- Links Between Younger Americans’ Balance Sheets and Economic Growth
now playing   William Emmons, Federal Reserve Bank of St. Louis (21:40)

- Discussant:
   Steve Fazzari, Washington University in St. Louis (18:14)

   Plenary One Q&A (15:06)

Plenary Two — Student Loans

- Student Loans and the Economic Activity of Young Consumers
   Meta Brown, Federal Reserve Bank of New York (21:12)

- Does Parents’ College Savings Reduce College Debt?
   Melinda Lewis, University of Kansas (18:11)

- Discussant:
   Alex Monge-Naranjo, Federal Reserve Bank of St. Louis (19:01)

   Plenary Two Q&A (18:22)


   Michael Sherraden, Washington University in St. Louis (2:52)

   Clint Zweifel, Missouri State Treasurer (6:26)

   Tishaura Jones, City of St. Louis Treasurer (6:14)

Concurrent Session I

- Moderator:
   Julie Birkenmaier, Saint Louis University (4:36)

- Toward Healthy Balance Sheets: The Role of Savings Accounts for Young Adults’ Asset Diversification and Accumulation
   Terri Friedline, University of Kansas (22:23)

- Financial Decisions of Young Households During the Great Recession: An Examination of the SCF 2007-09 Panel
   Wenhua Di, Federal Reserve Bank of Dallas (19:00)

- Discussant:
   John Sabelhaus, Board of Governors, Federal Reserve System (14:38)

   Session One Panel Response (6:57)

   Session One Q&A (5:41)

Concurrent Session II

- Impacts of Child Development Accounts on Change in Parental Educational Expectations: Evidence from a Statewide Social Experiment
   Michael Sherraden, Washington University in St. Louis (13:09)

- Trends and Patterns in the Asset Holdings of Young Households
   Ellen A. Merry, Board of Governors, Federal Reserve System (15:19)

- Discussant:
   Trina Williams Shanks, University of Michigan (7:06)

   Session Two Q&A (28:58)

Plenary Three — Homeownership

- Moderator:
   Todd Swanstrom, University of Missouri–St. Louis (5:54)

- Homeownership and Wealth Among Low-Income Young Adults: Evidence from the Community Advantage Program
   Blair Russell, Washington University in St. Louis (15:57)

- Aggregate and Distributional Dynamics of Consumer Credit in the U.S.
   Don Schlagenhauf, Federal Reserve Bank of St. Louis (21:53)

- Discussant:
   John Duca, Federal Reserve Bank of Dallas (13:59)

   Plenary Three Panel Response (6:40)

   Plenary Three Q&A (8:46)

Plenary Four — Economic Mobility

- Moderator:
   Jason Purnell, Washington University in St. Louis (2:00)

- The Balance Sheets and Economic Mobility of Generation X
   Diana Elliott, Pew Charitable Trusts (17:58)

- Coming of Age in the Early 1970s vs. the Early 1990s: Differences in Wealth Accumulation of Young Households in the United States, and Implications for Economic Mobility
   Daniel Cooper, Federal Reserve Bank of Boston (17:11)

- Discussant:
   Bhashkar Mazumder, Federal Reserve Bank of Chicago (16:15)

   Plenary Four Panel Response (3:14)

   Plenary Four Q&A (19:02)

Closing Reflections: From Research to Policy

   Michael Sherraden, Washington University in St. Louis (15:59)

   Ray Boshara, Federal Reserve Bank of St. Louis (9:30)

Thank You / Adjourn

   Julie Stackhouse, Federal Reserve Bank of St. Louis (5:59)


Below is a full transcript of this video presentation. It has not been edited or reviewed for accuracy or readability.

William Emmons: I’m Bill Emmons. And I speak only for Bryan and myself, not for the St. Louis Fed. So, I want to talk about young adults’ balance sheets and the economy. And in particular I’ll make a couple of points. Young adults are different. They’re fundamentally different. Young adults harm themselves with the added financial freedom in the eighties and nineties and 2000’s; especially the access to credit. And the contention here is that the young adults harm the economy too. And echoing what Neil said, researchers and policymakers should focus on repairing the damage. And we’re also going to agree with you Neil on exactly where to focus those efforts, and in preventing a recurrence. And remember, I speak only for Bryan and myself, not for the St. Louis Fed.

So, what is the balance sheet of a young person? It includes lots of potential. Probably good health. But no money. On the liability side, possibly college loans and lots of expenses either immediate or in the not too distant future. So it’s a very challenging balance sheet to deal with. That’s the first element. Young adults are different. They have a fundamentally different balance sheet challenge than older age groups. Second, there’s evidence that young people are impatient. This was a very well-constructed study that tried to isolate the impact of age alone on personal discount rates. And there is evidence of a U shape in discount rates over time. Young people discount the future at a higher rate. There’s also evidence that young people are impulsive. To quote something from the psychology literature, “Impulsivity in decision-making declines rapidly in young adulthood, reaching stable levels in the thirties.” So, the balance sheet challenge is different. Personal discounting rates are different. Impulsivity is different. So, does this actually matter in practice?

So, let me show you a series of examples of really financial mistakes that young people make. This compares driver fatalities, the risk of dying in a car accident. And this is by age. And notice there’s a U shape just as there was with discount rates. And in particular 25 year olds are about as dangerous to themselves driving as roughly 75 year olds. If you look at the risk of a young driver killing someone else it’s about the same. 25 year olds are about as dangerous on the road as 75, or in this case, 79 year olds.

What about strictly financial decision making? I won’t go into the details but this is an example of how quickly someone figures out how to use a tricky credit card offer, a balance transfer offer. And here you see an inverted U shape. But once again, young people are about as apt at making this decision as old people; 75, in this case, 73 year olds. What about making mistakes using credit cards; incurring late fees, cash advance fees, or over limit fees? Once again young people are about as likely to be tripped up by these tricks or traps, as one would say, as somebody who’s 75.

What about the ability to estimate the value of your house in order to refinance? Young people are about as likely as old people to make a mistake in estimating the value of their homes. Financial institutions are very aware of this. These are the loan rates that are offered according to age for fixed loans and lines of credit. Once again, young people and old people are offered higher rates than are middle aged people.

Automobile loans, also, young and old are offered higher rate loans. And both the mortgage case and the automobile case these are fully secured loans. So, what’s going on according to a paper, these are all taken from the paper in the discussion that Agarwal, Driscoll, Gabaix, and Laibson is there’s something of a trade-off going on. Young people are cognitively quicker and that declines with age. But on the other hand there’s a value of experience. So, these two things trade off against each other. And there’s probably some kind of a sweet spot. And, in fact, this article estimates it’s 53 years old. If you’re 53 you are the most effective decision-maker. And it’s downhill from there.

So, Bryan and I have spent a lot of time looking at the balance sheets of young adults. And so this is a lot of numbers and I’m only going to point to a few of them. Looking at the demographic characteristics of a family, and then in a regression framework, looking for the marginal contribution of that demographic characteristic in explaining various balance sheet characteristics. And the three that we’re going to look at across the top there are: having very low levels of liquid assets. So you’re at risk of missing debt payments. The share of assets invested in the housing. And the ratio of debt to total assets. So, how much leverage families have. And what we’ve estimated is that, as indicated here, young families compared—and this we’re defining under 40. Middle aged is 40 to 61. And older is 62 and over. The marginal contribution, simply of being young, controlling for a host of other factors is very significant. Young people’s balance sheets are less liquid. They have a lot more housing. And they have a lot more debt than people of older ages. And that’s probably related to some of the things I talked about. The impatience potentially, and just this challenge of a young person constructing a balance sheet.

So, did young adults in fact fare poorly? I think we’ve heard from Neil. We’ve heard from Lisa and Joanne there were some problems. And I’ll show you some evidence that financial liberalization harmed young adults or affected young adults the most. And I think you can argue that young adults were the biggest contributors to the housing and credit bubbles proportionately. So, this is something from one of my colleagues, Don Schlagenhauf, some work he’s done. This was an exercise that presented different mortgage contracts, different features to individuals modeled with different challenges. Young, middle, old, and other characteristics. And so what we’ve done here is pick out three of the mortgage contracts in their model that seem to resemble the most popular mortgages in the 2000’s. Graduated payment mortgage which was a very common subprime mortgage 228 convertible type mortgage interest only loans. And 80/20 piggyback second-lien combo loans. And what do we see? The U shape again. Young individuals and this is not assuming any irrationality on their part. It’s just given their circumstances. They were more likely to prefer these are sometimes called exotic mortgages. So, what happened, I think both Neil and Lisa mentioned this, homeownership rates soared among younger age groups. This is starting in 1994, these are census numbers. The homeownership rate for those under 30 went up eight percentage points which is very substantial since it’s a fairly low—I think it’s in the twenties as a percent of families. The next highest increase was among people in their thirties. And then the next was people in their seventies. So, if you can imagine there’s also a U-shape going on here too. The young and the old were the most aggressive in increasing their homeownership rates.

What about debt? This is from the New York Feds Consumer Credit Panel. This is the average debt adjusted for inflation by age group. And from the beginning of the data availability in 1999 you can see that under 30 households went up more than double the average amount of mortgage debt. The next highest category was the 30 to 39s. Then after the crash homeownership rates have plunged among 30 to 39 year olds, down ten percentage points between 2004 and 2013. The 40 to 49 group also down pretty substantially. The under thirties not quite as much. And in terms of reducing the amount of mortgage debt, fifty percent decline in just this seven year period for people under 30. And the next biggest decline was those under 40. So, I would say pretty clear evidence that on the upside and on the downside it was mostly young people, or at least they were in the vanguard in terms of homeownership increases and mortgage debt increases and then decreases. So, the net change in homeownership when you put all those periods together, from 1994 to 2013, looks like this by age group. And so the biggest declines are in the thirties and forties and even the fifties. But remember that people who now show up in their fifties were thirty when this began and 40 at the peak of the housing boom. So, some of these—and I think this echoes Neil’s point. That these effects follow these families as they age. And so it’s now moving into different age categories.

Well, we have a new office for the older Americans at the Consumer Financial Protection Bureau. And I think it bears mentioning—this maybe as a response to Michael’s question too. What do you do about this? Should we have an office for the protection of younger Americans in terms of their financial decision-making?

Okay. The third point is did young Americans’ financial experiences harm the economy overall. And I’m going to present some evidence that I think suggests young adults did contribute disproportionately to the housing boom and bust. And then I want to spend a little time using the generational perspective that Neil outlined to reemphasize and sort of illustrate the notion that different birth year cohorts have experienced this differently. And those effects are following through as they age. So, here’s evidence from Mian and Sufi who were at a conference last time, last year. They find evidence that young adults borrowed more aggressively during the boom. And this is controlling for lots of different factors. Young adults reacted more strongly to house price increases. So, their spending was more, seemed to be responsive to house price increases. And it also then turned out that default rates were higher among those groups. Not just the young but that is included in the groups that had been most aggressive in increasing their borrowing.

Bryan and I have done some work looking at homeownership among young families and we found that in general, over a number of waves of the Survey of Consumer Finances, young families generally have low levels of liquid assets, high concentrations in housing, and high debt. And I showed you those results before, those marginal effects. We also found that there seemed to be something special about their numbers in 2007 when one of the Survey of Consumer Finance waves was focused. Young families seem to be unusually likely, compared to their own history, compared to what was going on with other families, to be homeowners and to have very high debt at that point. So, they were seemingly the most affected by the housing bubble. This is from the Mian and Sufi work and contrasts the growth of debt. Young homeowners verses older homeowners and the distinction in the solid and dash lines are their attempts to control for, sort of, the pure effects of house prices on how people responded. And so the inelastic markets are those where there were bigger price increases in general. And you can see that the young homeowners were much more aggressive in responding to those shocks and increasing debt.

There’s also evidence at the county level that suggests household spending in a county was very sensitive to housing wealth shocks. Those local areas that had big increases in house prices had big increases in consumer spending. And it was also the case that areas with higher debt were also very sensitive to house price shock. So, it was an amplification mechanism. And, of course, as we’ve talked about, young adults had high and, in fact, increasing housing exposure during the boom and leverage.

There’s state level evidence that states with higher shares of young adults had more volatile housing markets. And higher concentrations of young adults increased the state economy’s sensitivity to the housing cycle. So, first this is a picture from some of the Mian, Rao, and Sufi work which shows this relationship, the bigger the net worth shock, in this case the negative shock, the bigger the decline in growth of consumer spending. So, it’s a real effect that housing shocks do seem to feed through in spending behavior. And this is based on Survey Consumer Finance. Finance is data, trying to illustrate the sensitivity of the different age groups to house price shocks. And so this is young families, middle aged, and older. How much would their net worth change in response to a 10 percent decline in house prices? So, of course, one thing is that young families always had more sensitivity because they had a higher housing concentration and more leverage. But what we’re really focused on here is that that was increasing significantly from 2001 to ’04 to ’07. Young households became increasingly sensitive to house price shocks. And then even more-so now after the decline.

This is a simple illustration of the relationship between the share of young adults in the population and the volatility of house prices. This is for the census division level. If you look at the 50 states the correlation isn’t quite as high. But it’s still very significantly positive.

Neil laid out the generations. We don’t have exactly the same break points. But it’s essentially the same idea. And so we now switch focus just a bit and look at generational trends. So, first income. This is the median income of families headed by someone born between 1945 and ’65. We’re going to call those boomers. This is a logarithmic scale. Then, if you superimpose on that, families headed by someone in Generation X defined as 1966 to ’80, you see that they’ve fallen off the path, exactly, as Neil showed. And then Generation Y is not so clear still. If you then compare the median Generation X to the median Baby Boomer at similar points in their life cycle, you can see that the Generation X has fallen off the pace. And maybe a little early to tell for Generation Y. But very much that Generation X was the harder hit of the two generations. Bryan and I have found in our regression framework that if you look for which generations seem to have done the best in terms of their income, controlling for all of the things that you think generate income, there is this very clear generational divide. The people born in the 1930’s and ‘40’s, the silent generation, we used as the benchmark. And everyone else relative to them, you can see now moving into the Baby Boom Generation X had significantly lower incomes controlling for all of the characteristics that you think would generate that income.

Now let’s switch to wealth. Here’s median net worth by generation. Boomers. Generation X. And Generation Y. And then again comparing the median Generation X to the median Baby Boomer, the median Generation Y to the median Baby Boomer, you see what I think is a fairly dramatic collapse in the wealth of Generation X. And again, in the regression framework, looking for, we’re predicting net worth of a family, controlling for lots of factors. When you were born seems to matter. People born in the thirties and forties using them as the reference point, as much as 40 percent less wealth for the same set of characteristics for people born in the 70’s. And a final attempt, or two more. Here’s consumer spending. And I think Neil spoke to this. The idea that there’s been this downturn recently that’s affecting subsequent generations.

And then finally, homeownership. So, this is tracking people born between 1964 and ’68 as they go through their lives at different stages of their life cycle. What was the home ownership reported by the census at that time? There’s the 1969 to ’73 which would be the beginnings of the Generation X. There’s ’74 to ’78. And ’79 to ’83. Which, by the way, Bryan and I think this is the group, this is ground zero; the age group that got hit the hardest by the housing crises. Now I want to just blow up the lower part of that diagram. So, here is that 79 to 83 group. Generation Y, now the millennials, and the latest group we have. So then, kind of summarizing if you compare when you were born along this axis here to two groups of Baby Boomers shown here, this is the difference at comparable stages in their life cycle as of 2013 in the homeownership rates. So, for this group, the ’79 to ’83 born group, almost eight percentage points lower than Baby Boomers at the comparable stage in the life cycle. So, you would think this group needs to work. They need to earn in order to try to recover from these shocks. So, these are employment to population ratios first for Baby Boomers, then Generation X and Generation Y. So, that doesn’t look so promising. The labor market is not helping them out at this point.

So, there is other research including some by Lisa. And I think Lisa and Joanne are working on some other work kind of related to this. That this housing shock seems to even effect fertility. That the birth rate seems to have been lowered because of big net worth shocks through housing. There’s also a lot of work suggesting—and we’re going to hear more about this later. That the balance sheet effects on college attendance, college completion, which college you apply to, has been effected by housing shocks.

And then if that wasn’t sort of convincing enough, this is what’s called generational accounting. This is looking for someone born in a given year. What is the net benefit you received from government minus the taxes that you pay over your lifetime, all in present value terms,. And so the big winners are the silent generation. And these are very large numbers. These are in the same order of magnitude as net wealth. In fact, the median net wealth, I think, was what? 77,000 dollars in 2010. So, these were the great beneficiaries. And who’s paying for that in a generational sense? Generation Y and X. On average, over their lifetimes they will have a huge transfer, pay more taxes than they receive in benefits. And, of course, due to the social safety net programs that we have. So, we think Fitzgerald was right, paraphrasing, the young are different than you and me. Cynically some people would say, yes, they haven’t lived as long. That’s it. But we think, no, Fitzgerald is right. The young really are different. And I think we continue to ignore this fact in research and policy at our peril. And not only did it affect those particular individual young families, it has affected the economy. And I think it has the potential to have long lasting effects.

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