Changing Retirement Behavior in the Wake of the Financial Crisis

The financial crisis and ensuing Great Recession left huge scars on household balance sheets, with households approaching retirement seeing the largest decline in wealth. This chapter examines how these households have adjusted to these developments. To date, most evidence on this question has come from surveys of household intentions. Using data on actual household behavior, we find that households nearing retirement are making up for financial losses by increasing saving and deferring retirement. They also appear to have reduced financial risk exposure by taking on less leverage and moving their portfolios in a more conservative direction. Disciplines Economics This working paper is available at ScholarlyCommons: https://repository.upenn. edu/prc_papers/171 Changing Retirement Behavior in the Wake of the Financial Crisis Julia Coronado and Karen Dynan September 2011 PRC WP2011-07 Pension Research Council Working Paper Pension Research Council The Wharton School, University of Pennsylvania 3620 Locust Walk, 3000 SH-DH Philadelphia, PA 19104-6302 Tel: 215.898. 7620 Fax: 215.573. 3418 Email: prc@wharton.upenn. edu http://www.pensionresearchcouncil. org The authors thank John Soroushian for excellent research assistance, and David Richardson and participants at the Pension Research Council Spring Symposium for helpful comments. All findings, interpretations, and conclusions of this paper represent the views of the authors and not those of the Wharton School or the Pension Research Council. © 2011 Pension Research Council of the Wharton School of the University of Pennsylvania. All rights reserved. Changing Retirement Behavior in the Wake of the Financial Crisis Abstract The financial crisis and ensuing Great Recession left huge scars on household balance sheets, with households approaching retirement seeing the largest decline in wealth. This chapter examines how these households have adjusted to these developments. To date, most evidence on this question has come from surveys of household intentions. Using data on actual household behavior, we find that households nearing retirement are making up for financial losses by increasing saving and deferring retirement. They also appear to have reduced financial risk exposure by taking on less leverage and moving their portfolios in a more conservative direction. Julia Coronado BNP Paribas julia.l. coronado@americas.bnpparibas. com Karen Dynan Brookings Institute kdynan@brookings.edu Changing Retirement Behavior in the Wake of the Financial Crisis Julia Coronado and Karen Dynan The financial crisis and ensuing Great Recession have left huge scars on household balance sheets. Stock prices remain below their peak of the fall of 2007. Home prices fell more than a quarter from their 2006 peak and continue to fall. Households have shed some of their debt (in large part through defaults), but the decline has not been nearly as large as the decline in the value of their assets, leaving the ratio of debt to assets well above its pre-crisis range. Looking across age groups, households approaching retirement have seen the largest decline in wealth. These households were in their peak lifecycle wealth accumulation years when the crisis hit, and they were holding much of this wealth in equities or homes. With fewer years of earnings ahead than their younger counterparts, they have fewer options to make up for this loss in wealth and must make a number of significant economic decisions as a result. This chapter examines how households approaching retirement have adjusted to these balance sheet developments. To date, much of the evidence on this question has come from surveys that ask households how they are adjusting or plan to adjust (c.f. Sass, Monk, and Haverstick, 2010; Hurd and Rohwedder, 2011). Such evidence is useful but remains limited, in that intentions do not always correspond to actions. This chapter complements the survey evidence with a careful look at the available data on what households approaching retirement are actually doing—how households are adjusting their consumption, labor supply, and asset allocation. We begin with a review of macroeconomic and financial developments over the past few years and then explore exactly how these developments have affected the financial conditions of households in different age groups. Next we turn to the different margins on which households may be adjusting. We look at patterns of consumption and labor supply across age groups, using past recessions as a benchmark; we also examine financial decisions including willingness to borrow and asset allocation. Whereas the survey evidence is mixed on whether households are adjusting to their wealth losses by trimming their spending, households do seem to have adjusted on this margin. In particular, households on the cusp of retirement have seen a sharp and broad-based decline in their spending, in contrast to a fairly muted reduction for households in the age categories on either side of this group. Patterns of labor force participation by age are consistent with survey data, indicating a strong inclination toward deferring retirement to make up for the losses. Finally, the financial crisis appears to have left an imprint on financial behavior, with a significant reduction in willingness to take on debt and considerable wealth having been moved out of higher-risk equity funds and into lower-risk bond funds. Boom and bust in the early 2000s To set the stage for our analysis, it is useful to briefly review the events of the last decade and their implications for household finances. Following a brief and mild recession in 2001, the United States saw considerable run-ups in stock prices and home prices paired with solid economic growth and low rates of unemployment. Aggregate household net worth relative to disposable income rose sharply to a high of 6.4 in mid-2007, noticeably above the peak reached during the stock market bubble of the late 1990s (Figure 1). Ultimately, the good times proved transitory, however. Home prices began to decline in 2006, and stock prices turned down in late 2007 (Figure 2). Figures 1 and 2 here Housing played a special role in the recent economic cycle. In retrospect, home values clearly rose above levels that could be justified by economic fundamentals. Housing has historically been the most widely held asset among US households, and it became even more broadly based as homeownership rates rose from the 63-66 percent range observed between 1965 and 1998, to around 69 percent between 2004 and 2007 (Figure 3). The expansion in home ownership was fueled, in part, by a slackening of mortgage underwriting standards, including a sharp rise in the prevalence of so-called ‘affordable’ mortgages. However, many of these mortgages proved to be unsustainable in the absence of continued home price appreciation. As home prices began to fall, losses mounted at financial institutions and many collapsed or threatened to do so. In turn, credit conditions began to tighten, leading to yet more defaults and credit losses, until the US found itself in the most severe financial crisis and economic downturn since the Great Depression. Figure 3 here Stock ownership has also expanded in recent decades. The Survey of Consumer Finances (SCF) conducted by the Federal Reserve Board shows an increase in stock ownership (both directly and indirectly held) from 37 percent of households in 1992 to 51 percent in 2007 (Aizcorbe, Kennickell, and Moore, 2003; Bucks et al., 2009). Homeowners tended to have greater exposure to stock than renters, with 63 percent holding equity in 2007 (about 21⁄2 times the corresponding share of renters). Amid the boom in equity and home values, consumers took on unprecedented amounts of debt. The ratio of household debt to disposable income (Figure 4) rose steadily in the 1980s and 1990s as the liberalization of financial markets and improvements in technology for assessing risk increased access to credit and lowered the cost of borrowing. The trend sharply accelerated in 2002, with household debt surging above 100 percent of disposable income and reaching a peak of 130 percent in the third quarter of 2007. Rising debt levels left household vulnerable to shocks that left them with elevated debt obligations relative to their available resources (Dynan, 2009). Figure 4 here By early 2009, aggregate stock market wealth was 50 percent below its peak in October 2007, while the value of aggregate household real estate holdings were down a quarter from their peak two years prior. The ratio of household wealth to disposable income bottomed out at 4.5 in early 2009, its lowest level since the mid-1980s. The combination of elevated debt burdens and depleted balance sheets left households under enormous strain. The ratio of debt to asset values, which had shown fairly subdued growth between 2002 and 2007 because of rising asset values, exploded upward with the collapse in asset values. The recession also had a profound effect on employment conditions. Nearly nine million jobs were lost to the downturn. When employment conditions reached their trough in late 2009, the unemployment rate was over 10 percent and the ‘underemployment rate’ (which includes part-time workers that would like to be fully employed and workers not actively seeking a job because they are discouraged) was 17.2 percent. Since that time, the economy has remained weak and improved only modestly in terms of broader conditions and household financial conditions. More than one in 12 workers is still without a job. Long-term unemployment trends have been particularly troubling, with the fraction of workers unemployed for 27 weeks or more, at 4 percent, still well above the range seen for decades prior to this recession. The ratio of household wealth to income has recovered a bit, but it remains no higher than it was in the early 1990s. Impact of the Great Recession on the finances of different age groups We use t