Meet the Author

O. Emre Ergungor |

Assistant Vice President and Economist

O. Emre Ergungor

Emre Ergungor is an assistant vice president and economist in the Research Department at the Federal Reserve Bank of Cleveland. He is responsible for the household finance section of the Banking Policy and Analysis Group, which conducts research on regulatory policy and banking issues and provides advice on financial policy formulation. He also oversees the Federal Reserve System’s Muni Financial Monitoring Team (FMT), which monitors municipal bond markets, state and local funding, and public pension funds. Dr. Ergungor specializes in research related to financial intermediation, information economics, housing policy, and credit access in low- to moderate-income households.

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Meet the Author

Nelson Oliver |

Research Analyst

Nelson Oliver

Nelson Oliver is a research analyst in the Research Department of the Federal Reserve Bank of Cleveland. His primary interests include urban revitalization, housing policy, and applied microeconomics.

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Economic Trends

Household Finances

O. Emre Ergungor and Nelson Oliver

Consumption accounts for roughly 70 percent of gross domestic product (GDP). Consequently, households’ spending behavior is of utmost interest to policymakers.

In thinking about household finances, the obvious primary resource available for new consumption is disposable personal income. From 1990 to 2007, annual changes to personal consumption expenditures (PCE) and disposable income fluctuated within a definable range of roughly 2 percent to 8 percent.

However, the recession and financial crisis in 2008 pushed both disposable income and consumption growth negative for the first time in over 20 years. Income growth briefly exceeded its 20-year average in 2010, but it is currently moving toward levels often associated with economic stress. Consumption growth still maintains its upward trend, but it has barely reached its 20-year average. Consumption and incomes have to grow at a much higher clip to make up for the lost crisis years.

Household spending can also be funded through debt if consumers expect their incomes to grow and want to smooth their consumption (maintain a constant or steadily rising level of consumption over time). New individual borrowing as a percentage of GDP is still negative after passing zero in mid-2008. Moreover, it has renewed its downward trend, meaning that on a net, aggregated basis loans are either being paid off (and not renewed) or are defaulting, or a combination of the two. For a sense of historical perspective, consider that the average borrowing level from 1990 to 2000 was about 4 percent of GDP before the loose loan underwriting environment of the 2000s set in.

The personal savings rate, at 5.4 percent in June 2011, shows that households are saving more, which explains part of the shrinkage in aggregate loans.

Some of this contraction can also be explained by higher-than-average defaults on mortgages, consumer loans, and credit cards, as the figure below shows. While the charge-offs in securitization pools for credit card receipts have declined sharply from their peak in the middle of last year, they are barely below the peak reached during the 2001 recession. Bank mortgage charge-offs are still at historically elevated levels despite the decline since the end of the recession. Whether consumers are paying down existing debt through savings or banks are writing bad loans off, the result is less aggregate debt in the financial system.

As debt levels shrink, consumers are spending less of their disposable income on repayments related to mortgages and consumer loans. The household debt service ratio, which measures repayments as a share of income, has been consistently falling since the third quarter of 2008. Much of the drop is likely to be coming from historically low interest rates, which lower debt service requirements on new debt, refinanced debt, or debt that carries floating interest rates. The ratio is now well below the average levels seen from 1990 to 2000, and it is rapidly approaching its lowest levels since 1993-1994. While the ratio may potentially undershoot its long-term average, its sharp decline since 2008 indicates that the debt-service burden has fallen substantially, which may make borrowers more inclined to borrow again and financial institutions more willing to lend.

According to the April 2011 Senior Loan Officer Survey, banks are showing greater enthusiasm to lend. The net percentage of domestic respondents reporting increased willingness to make consumer loans is at its highest level since the early 1990s.

Banks are also easing their lending standards, albeit from very tight levels. Starting in April 2011, the Senior Loan Officer Survey reports the responses related to credit cards, auto loans, and other consumer loans separately. In the credit card category, we observe the largest net percentage of lenders easing lending standards since the credit boom years. This is followed by auto loans, and then by other consumer loans.

Banks are also reporting stronger consumer loan demand. The leading category is auto loans, by a wide margin. Demand for credit cards has weakened slightly.

Overall, the data shown here suggest that consumers are still paying down loans or defaulting, but it seems like the worst is behind us and banks are no longer pulling back on lending. Still, slow income growth and the continuing deleveraging of consumer balance sheets may damp consumers’ motivation to ramp up their expenditures immediately.