William C Dudley: Remarks at the New York Fed's Economic Press
Briefing on the Household Debt and Credit Report
Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal
Reserve Bank of New York, at the New York Fed's Economic Press Briefing on the
Household Debt and Credit Report, New York City, 12 February 2016.
* * *
Domenico Giannone, Andrew Haughwout, Joseph Tracy and Wilbert van der Klaauw assisted in preparing these
remarks.
Good morning and welcome to the Federal Reserve Bank of New York's Economic Press
Briefing. I am pleased to have this opportunity to speak with you today about the economic
outlook, with a focus on the household sector. As always, what I have to say reflects my own
views and not necessarily those of the Federal Open Market Committee (FOMC) or the
Federal Reserve System.
According to the National Bureau of Economic Research, the current expansion began in
July 2009, making it nearly seven years old. If we gathered this expansion and the 11 prior
post-WWII expansions together for a family photograph, arranging them by age from
youngest in front to oldest in back, this expansion would be standing third from the rear. The
only two that lasted longer were the expansion that began in February of 1961, which lasted
for nearly nine years, and the one that began in March of 1991, which lasted for ten years.
Thus, the current expansion is already an elder statesman in the family of post-war U.S.
expansions. This raises the question of whether this expansion has already entered its
twilight years, with the risk of recession edging higher with each passing month.
As I have said before, expansions do not simply die of old age.1 Rather, expansions end
either because a significant inflation risk emerges that requires a sharp tightening of
monetary policy, or the economy is adversely impacted by a large shock that cannot be
offset by monetary policy in a timely manner. While the sample of post-war U.S. expansions
is still too small for reliable statistical analysis, the evidence suggests that after an
expansion's first few years its likelihood of ending is mostly independent of age, and depends
mainly instead on the level of inflation. Since the possibility is low that a significant inflation
risk would emerge over the near term, this means that the main danger facing the current
expansion is the risk of large, adverse shocks.
Given that the labor market still appears to have some excess slack and inflation is below the
Federal Reserve's objective, monetary policy is appropriately still quite accommodative
despite the advancing age of the expansion. While this limits to an extent the degree to
which monetary policy can aggressively respond to any adverse events, the good news is
that the economy is more resilient to any shocks. Key sectors of the U.S. economy, such as
the household sector, seem to be in good shape. The financial system is also clearly much
stronger, with the banking system much better capitalized and with much larger liquidity
buffers than in the years preceding the financial crisis.
In today's briefing, we will be focusing on the household sector. Given the importance of
consumption to U.S. economic growth, the health of the household sector is critical for an
assessment of risks to the outlook. Over the last several years we have devoted significant
resources to better understanding the state of the household sector, and one outcome of this
attention is our now well-known Quarterly Report on Household Debt and Credit. This report,
and the data that underlie it, give us direct insight into the health of the household balance
sheet. The assets and liabilities that families hold is a crucial determinant of the household
sector's ability to help immunize the economy from shocks. We learned during the Great
Recession the importance of household liabilities - in particular, mortgages, which make up
more than two-thirds of the sector's total liabilities.
As you know, the early part of the 2000s witnessed a very substantial expansion in borrowing
by households. This borrowing took many forms, but was particularly notable in mortgages
and home equity lines of credit, and reflected the very high and unsustainable expectations
of house price appreciation. Household debts peaked in 2008, at which point the sector's
balance sheet was weak. Households were highly-leveraged, with many underwater on their
mortgages. This was particularly the case for younger and lower- and middle-income
households who, besides being more leveraged, were disproportionally affected by job loss
and other income shocks, and had little experience managing debts - especially in times of
stress. Consequently, delinquency, foreclosure and bankruptcy rates reached very high
levels.
Beginning in 2008, households began a new phase to repair their balance sheets by paying
down outstanding debt. During this "Great Deleveraging," which lasted five years,
households reduced their overall liabilities by 12 percent or $1.5 trillion. House prices began
to rise again in earnest in 2012, and by mid-2013 household deleveraging appeared to have
come to an end. Net household borrowing resumed, and household debt has risen over
8 percent during the last couple of years. But, this recent period of credit expansion looks
very different from the early 2000s, and I believe that the household sector today is in much
better health. There are several reasons for my confidence.
Let me begin with the situation in the residential mortgage market, which plays such a
dominant role in household finance and was such a problem the last time around. Currently,
house price growth is running nationally at around 5 percent per year. But this time,
households appear to be much more cautious in how they are responding to the rise in home
values. Rather than borrowing against the rising equity in their homes, mortgage balances
have instead essentially stabilized and remain well below their previous levels. As my
colleagues will describe in more detail shortly, this stabilization reflects an increase in debt
paydown due to a combination of lower interest rates, shorter loan terms and aging of
mortgages. This trend is reflected in increased household saving and growing home equity,
and we expect these trends to continue to help households rebuild their balance sheets over
the near term, thereby further increasing the household sector's resiliency to shocks.
Low interest rates have also been important in driving the household debt service ratio to the
lowest levels observed in our data. This means that households have more capacity with
which to absorb any temporary adverse income shocks. One clear reflection of these
improvements is the very significant decline in delinquency rates. At this point, the great
majority of the bad debt from the boom years has been charged off and new foreclosures are
at the lowest level we've seen in our data. The combination of charge-offs and tight mortgage
underwriting standards over the last several years has shifted the stock of outstanding
mortgage balances toward lower-risk borrowers, who are typically older with more stable
incomes.
For all these reasons, the household sector looks much better positioned today than in 2008
to absorb shocks and continue to contribute to the economic expansion.
Now, before asking my colleagues to discuss some of these trends in more detail, let me
note that my positive overview of the household sector comes with some caveats. First,
these aggregate statistics can mask some important variations, and there are some local
markets where, as in the prior boom, both house prices and mortgage growth are quite
strong. Similarly, there exist substantial differences across households in their financial
situation and their ability to improve their balance sheets. Borrowers with little equity, low
credit scores and slow income growth face difficulties refinancing into low rate mortgages. As
a result, this subset of the population has been less able to deleverage and still faces
relatively high debt service costs, which constrains their consumption, investment and saving
behavior. So, even within what looks to be a stable overall mortgage market, there are some
things that we must continue to monitor. Second, there are other difficult challenges that
many households face, particularly with respect to a subject we've discussed on previous
occasions - student loans. On balance, though, households are in a much better position
today than they were in 2008. Now, I'd like to turn things over to our economists, beginning
with Andrew Haughwout, who will provide a more detailed discussion of household sector
finances.