U.S. Department of the Treasury

(Archived Content)

Credit Counselor Speech

Thank you, Cathy, for that wonderful introduction.  As chief economist at Treasury, I cover many topics, but my roots as a researcher are in consumer financial issues, so I have a great appreciation of the important role that credit counselors play.  Today, I will be sharing my thoughts on the U.S. economy and consumer finances.  I am also eager to hear your perspectives on the opportunities and challenges presented by how Americans are using credit.

I am going to start with the forces—both positive and negative—that are shaping the economic outlook in this country.  Next, I will discuss in more detail the linkages between economic activity and the finances of American households.  I will focus in particular on how credit use is being influenced by some key developments in household formation, homeownership, higher education, auto purchases, and entrepreneurship.  

 

State of the U.S. Economy

The Recovery from the Financial Crisis

The recovery of the U.S. economy from the financial crisis and the Great Recession has been slower than anyone would have liked.  But, we have truly come a long way.  The collapse of the housing bubble and the resulting financial distress were the biggest shock to the economy in more than 75 years.  The plunge in housing construction and the pullbacks in consumer spending and business investment led to sharp declines in employment and incomes that, in turn, led to further weakness in household and business spending.

Policymakers responded vigorously to the crisis.  The Federal Reserve and other financial regulators put forward a set of policies to help maintain liquidity in the financial system. TARP (Troubled Asset Relief Program) provided an additional mechanism for addressing the problems faced by many financial institutions.  Government housing relief measures such as the Home Affordable Modification Program and the Hardest Hit Fund helped millions of distressed mortgage borrowers.

Significant changes to monetary and fiscal policies were swiftly implemented as well.  The Fed cut its policy rate to nearly zero.  The Administration and Congress put in place the American Recovery and Reinvestment Act, which increased government spending, including crucial investments, and also cut taxes to stimulate private spending. 

Collectively, these policy actions helped to arrest the decline in output and set the stage for recovery.

The economic recovery has been slow, as is typical after financial crises.  However, our economy has an underlying resilience, and, supported by the policies I just discussed along with some subsequent monetary and fiscal actions, it has expanded significantly over the past six years.  Real GDP has now surpassed its pre-recession peak by almost 9 percent, and, private employment has increased every month since February 2010, bringing the total number of jobs created by American businesses since then to 13 million. 

 

The Economic Outlook

Turning to the economic outlook, the underpinnings of household and business spending are now solid.  For households, incomes are generally rising and are poised to increase more rapidly as the labor market improves further.  Consumer confidence is near an eight-year high.  In addition, as I’ll discuss in further detail in a few minutes, household financial conditions are, on the whole, much better than they were a few years ago.  Companies are flush with cash, and rising capacity utilization and falling nonresidential vacancy rates suggest that business investment, at least outside the energy sector, will rise briskly in coming quarters.

Moreover, the substantial decline in oil prices has been, on net, a plus for the U.S. economy.  We estimate that each 1-cent decrease in the price of gasoline saves American consumers roughly $1 billion a year.  With gasoline prices down about $1 per gallon over the past year, consumers now have $100 billion to put toward other uses than they had 12 months ago.  Similarly, falling fuel prices lower businesses’ costs of production, freeing up resources that can be used to add to payrolls, increase capital spending, or passed on to customers in the form of lower prices.  Of course, the downside to lower oil prices is the negative effect on oil producers.  Indeed, a drop in mining and oil exploration has offset some of the boost to GDP associated with the savings for consumers and businesses that are not in the energy sector. 

The labor market has also shown notable improvement.  Payrolls are up by more than 8 million since August 2012, the strongest 3 years of job creation since 2000.  The unemployment rate has fallen by nearly 3 percentage points over that same period to 5.1 percent, the lowest level since April 2008.  Long-term unemployment has fallen considerably, and the rate of involuntary part-time employment, while still unusually elevated, is trending down as well.

Other factors bode well for economic prospects over the medium and long run.  Our manufacturers are consistently creating jobs for the first time in decades, and investment in manufacturing plants has more than doubled in the last four years. We now produce more oil domestically than we import, and we are converting terminals that before were used to import natural gas for export.

In addition, the government has undertaken important structural reforms that will support sustained economic expansion and help to ensure that prosperity is broadly shared.  Among those reforms, the Dodd-Frank Wall Street Reform and Consumer Protection Act has strengthened our financial system and established new rules of the road to make our the system safer for consumers, investors, and other market participants.  The Affordable Care Act has expanded access to affordable health insurance and is reforming our health care delivery system to reduce costs and improve quality.

To be sure, there are risks to the economic outlook that bear watching.  Productivity growth, a key determinant of how fast our living standards rise, has been weak over the last several years.  But, I expect it will increase as the expansion continues.  One promising sign in that regard is that growth in some key types of business investment, such as software and R&D, has picked up notably over the last year or so.

Another challenge is that many of our major trading partners are struggling economically.  Growth in the Euro area is sluggish overall.  At the same time, economic growth is weakening in Asia.  China is experiencing a marked slowdown—part cyclical but also structural—which is having substantial spillover effects to other countries that export raw materials or other items to China, including a number of countries in Asia and as well as in other parts of the world.  

We believe that with good policy choices, China and other countries can achieve strong economic growth.  Currently, however, the weakness in other economies is weighing on demand for our exports.  Our financial markets are also exposed to troubles abroad because many companies do business globally.  As we saw just a few weeks ago, concerns about growth in China and elsewhere can quickly translate into equity market declines in the United States.  Such declines reduce household wealth and can dent consumer and business confidence.  So, not surprisingly, we are watching economic developments overseas very closely. 

Taking all of these factors together, the consensus projection of private forecasters is that real U.S. GDP will expand at an annual rate of roughly 2½ percent over the second half of 2015 and 2¾ percent over the four quarters of 2016.  I share their positive outlook and believe that higher growth will translate into more employment and more economic opportunity for Americans.

Household Finances

The Strengthening of Household Balance Sheets

For the remainder of the talk, I am going to drill down into the finances of U.S. households and especially their use of credit.  As with the broader economy, a great deal of progress in household finances has been made since the financial crisis.  Total household debt outstanding as a share of disposable personal income has fallen by roughly one-fifth, from a pre-crisis peak of nearly 130 percent in 2007 to just over 100 percent now—about the same as it was in early 2003.  The decline in household debt, together with the low interest rates of recent years, has resulted in a decline in the aggregate share of disposable income committed to debt service payments to its lowest level since at least 1980, when the series began. 

Meanwhile, household net worth has recovered from its steep plunge during the financial crisis.  As of mid-2015, household wealth relative to disposable income stood at 645 percent, a level last seen in late 2007.  Rising equity prices have fueled much of the gain in recent years, and, even with the setback in equity markets over the last few months, stock market wealth is still near historical highs.  In addition, as of mid-2015, the value of real estate owned by households had regained about three-quarters of the loss seen during the housing bust, although, of course, the experience has been different depending on the area and the market segment.

Of course, we need to recognize that not all households have shared in this improvement. A key lesson of the financial crisis is that aggregate measures can mask distress in certain segments of the population, which can then pose risks to the broader economy.  So, we also monitor measures of financial conditions that pick up what is going on in the most at-risk segments of the population.  To that end, I will note that the number of mortgages with negative equity has dropped by close to two-thirds since late 2011, to roughly 4½ million.  And, delinquency rates on most types of household loans have been coming down as the economy has strengthened, although some remain elevated.

With that background in mind, let me now turn to some important economic developments that are shaping household credit usage going forward—in the areas of household formation and homeownership, education, auto purchases, and entrepreneurship.

 

Household Formation and Homeownership

As credit counselors, you know that the mortgage borrowing associated with home purchases represents the most important use of credit for many households.  To understand where mortgage borrowing is likely to go in the future, we need to look at the determinants of homeownership, but before we do that, we need to explore what is typically an even earlier stage of the lifecycle—the point at which individuals stop living with their families or roommates and form independent households.

Household formation has been unusually low for most of the past decade.  From 1966 to 2007, the number of households in this country increased by 1.3 million per year on average.  Since then, household formation has averaged only about half that pace.

A closely related phenomenon is the rise in young adults living with their parents.  The share of young adults aged 18 to 34 living with their parents averaged 27 percent in the mid-2000s, but rose to roughly 31 percent by 2012 and has stayed close to that level since then.  The development is not just limited to individuals in their late teens and early 20s—about one in seven adults aged 25 to 34 is still living at home, up from one in 10 in the mid-2000s.

Several inter-related factors have likely contributed to the lower rates of household formation.  High joblessness and weak income growth in the wake of the Great Recession probably represented the biggest obstacles to people forming independent households.  An increase in the number of people seeking higher education and a rise in age at first marriage likely played a role as well.  Affordability may also be an issue, as rents have been rising faster than wages in recent years, and concerns have been raised about the role of student loans, although research findings on that topic are mixed.

The good news is that the strong pace of job creation we have seen over the past year has been accompanied by a pickup in household formation.  Over the year ending in June, 1.7 million new households were formed—exceeding the average pre-crisis pace by about 1/3 million.  The continued improvement in labor market conditions that we are expecting should support a brisk pace of household formation going forward.

Household formation is often followed, of course, by homeownership.  We have seen a considerable drop in the homeownership rate in the past few years from a peak of 69.2 percent in early 2005 to 63.5 percent now—the lowest rate in almost 40 years.  The pickup in household formation in the past year has played some role because new households tend to rent, which naturally lowers the share of households that own.  But this relatively benign explanation is just a recent phenomenon:  Most of the decline in homeownership following the Great Recession reflected the cyclical weakness of the economy and tight credit conditions.

Despite some speculation to the contrary, most young adults today still aspire to own a home.  According to a 2013 Federal Reserve Board survey, 87 percent of young adults who were renting said that they would prefer to own if they could afford it.[1]  Of those who would prefer to own, 59 percent cited a lack of a downpayment and 35 percent cited not qualifying for a mortgage as factors holding them back.

The Administration is keenly aware that mortgage credit availability appears to be too limited given underlying economic conditions. We are working to draw more private capital back into the mortgage market and to reduce the obstacles that may be weighing on lenders’ willingness to extend loans.  Under the direction of the Federal Housing Finance Agency, the GSEs reformed their buyback practices, and the Federal Housing Administration is in the process of doing the same.  Treasury has been working with the industry to develop the structural reforms necessary to help bring the private-label securities market back.  These steps, along with the improving economy, should increase credit availability and lead to a rise in the number of homeowners. 

Higher Education

Another distinguishing feature of today’s young adults is their interest in higher education.  In 2014, 46 percent of 25 to 34 year-olds had received an associate’s or bachelor’s degree, up from about 30 percent in the early 1990s.[2]  This increase in educational attainment is a very positive development.  A more educated workforce raises the productivity of our economy.  In addition, higher education remains an excellent investment for most people.  On average, a four-year college degree yields about $570,000 more in lifetime earnings than a high school diploma alone, while a two-year degree yields $170,000 more than a high school diploma.^[3]

Yet, there are challenges associated with this trend.  As you are well aware, students have had to borrow much more in recent years to finance their higher educations, with outstanding student debt now at $1.3 trillion, up from $0.5 trillion in 2006.[4]  This increase is partly related to rising college costs.  It also reflects students and their families having more limited financial assets on hand to cover those costs, both because people from lower-wealth backgrounds are more likely to seek higher education today and because the financial crisis and Great Recession depleted many families’ resources. 

Most people who borrow using student loans will be in a very good position later to pay off their debt because the boost to their incomes over their lifetimes tends to far exceed the amount they borrow.  Of course, some borrowers experience temporary periods of unemployment or low income, particularly early in their careers.  Today, borrowers facing such problems can make use of federal student loan income-driven repayment plans that align monthly payments to income.

A bigger challenge, and one that Treasury Deputy Secretary Raskin highlighted yesterday, is associated with students who borrow to invest in higher education that turns out to be of poor quality.  Recent research has documented the striking rise in borrowing by students at non-selective institutions of higher education, particularly for-profit establishments, and the subsequent high rates of default and delinquency for those borrowers.[5]  Many of the borrowers from these establishments are from relatively disadvantaged backgrounds to begin with, leave school without completing a degree, and experience high rates of unemployment and low earnings after leaving college.  Although they typically have lower debt burdens than students from more selective 4-year institutions, their meager earnings leave little to no capacity to pay off their debt. 

As Deputy Secretary Raskin stressed, the Administration is focused on addressing this problem along two dimensions—first, by improving the information that prospective students have when making choices about higher education, and, second, by holding higher education institutions accountable for the outcomes of their students.                                                                           

We are already starting to see improving trends regarding student loans.  Job prospects have strengthened with the economy, heightening borrowers’ ability to repay, and we are seeing reduced defaults among the borrowers who most recently entered repayment.  At the same time, the number of new borrowers at non-selective institutions has receded, both due to the stronger economy and due to increased scrutiny of these schools.

Auto Purchases

Let me turn now to consumer purchases of motor vehicles, another important driver of household credit.  Sales of cars and light trucks have been on a strong uptrend of late.  In the first eight months of 2015, sales of new light vehicles ran at an average annualized rate of 17.1 million; if sales continue at this pace, we will see the best year since 2001.  That households have the wherewithal and confidence to make these purchases is a very promising sign about the strength of consumer demand going forward. 

Pickups in auto purchases tend to be correlated with increases in borrowing to finance such purchases, and, as you know, the recent period is no exception.  Motor vehicle loans have trending up at an annual rate of 8 to 9 percent for the last couple of years and, as of mid-2015, they were more than 20 percent above their pre-recession peak. 

The rapid growth in motor vehicle debt raises questions of whether it is putting vulnerable households at risk.  We know that the required monthly payments associated with motor vehicle debt are material for many borrowers:  As of 2013, auto loan payments represented 8 percent of before-tax household income for the median borrower and was a fifth or more of income for 10 percent of borrowers.  That said, the overall delinquency rate on auto loans—the most direct measure of the strain these loans are putting on households—has continued to trend down, and, at 2.3 percent, it is closing in on its pre-recession average.

Still, we are closely watching subprime motor vehicle loans.  According to Experian,[6] the share of motor vehicle loans to borrowers with credit scores of 600 or below has remained stable over the last several years at around 12 percent.  But, of course, the dollar volume of subprime motor vehicle loans has risen rapidly along with other types of motor vehicle loans.  Partly in the recognition of the risks to vulnerable borrowers associated with such loans, the Consumer Financial Protection Bureau has moved to extend its supervision of auto financing beyond banks and credit unions to large nonbank lenders.

Entrepreneurship

Lastly I want to talk a little about entrepreneurship.  I am raising this topic here because households often fund new businesses using forms of personal credit such as credit cards or home equity loans.  Entrepreneurship is very important because it makes our economy more dynamic, raising productivity, wages, and employment.  It also is a potential way for households to boost their incomes and build wealth.

Unfortunately, entrepreneurship appears to have been declining for some time.  While tech startups regularly make headlines, the data suggest a different story for entrepreneurship as a whole.  The share of new firms among all firms, also called the “start-up” rate, has trended down over the past several decades from 12.5 percent in 1980 to around 8 percent in 2013 (which is the latest available data point).

Research has documented that while many startups unfortunately fail, the ones that succeed are crucial for overall job growth.  Indeed, a small fraction of young firms grow very rapidly and contribute substantially to job creation.[7]  As a result, economists view the lower rate of firm start-up as closely linked to another concerning trend—a decline in so-called “churn” in the labor market, meaning movement into and out of jobs through hires, quits, layoffs and other types of discharges. 

Although some churn heightens worker anxiety, churn also creates opportunities for workers.  When workers move between jobs, they can find a better match between the skills they have and the jobs that use those skills to the fullest extent.  Better matches raise productivity, wages and living standards. 

More limited access to credit in the wake of the financial crisis has hindered entrepreneurship.[8]  Both the depletion of home equity and the general pullback in mortgage lending made it difficult to borrow against one’s home for such funding, and access to funding through credit cards was also restrained.  These circumstances made it more difficult for would-be entrepreneurs to borrow funds to start new businesses and for established entrepreneurs to weather hard times. 

The good news is that access to credit is now increasing with the easing of credit conditions and the partial recovery in home equity in recent years.  Commercial and industrial loans to small businesses have risen 8.4 percent since the second quarter of 2012, and bank loan officers have been reporting that they are continuing to unwind the tightening of standards on loans to small businesses that occurred during the recession. 

Administration policies are also helping on this front.  Since its establishment in 2010, the State Small Business Credit Initiative (SSBCI) has supported more than $6 billion of new private lending to small businesses, including both start-ups and Main Street businesses in communities across the country.  In addition, the Small Business Lending Fund has provided capital to qualified community banks and community development loan funds in order to encourage small business lending.  Over the last five years, participants in the Small Business Lending Fund increased their small business lending by about 70 percent.

Conclusion

In closing, I want to come back to where I started.  The U.S. economy is moving solidly forward and future growth prospects are good.  Household credit is expanding along with the economy.  However, credit growth is not an objective in and of itself.  We need to be sure that credit is be used well and provided on fair terms to borrowers who understand their loans and can make their payments.  In that regard, your experience as credit counselors provides a very useful perspective.  I look forward to hearing your comments and would be pleased to take any questions.

 

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