Could the Crisis Have Been Predicted? What the Fed's new report tells us

Posted by: Michael Mandel on February 12

Every three years the Federal Reserve does an extensive survey of consumers to find out about their financial position. This afternoon they released the results of their 2007 Survey of Consumer Finances, a very lengthy document. As the name suggests, the survey was done in 2007, before the financial crisis hit.

So here’s the question: Does the survey give any warning signs that consumers were overstressed and that the sky was about to fall down?

The short answer is basically no. You can see the subprime crisis developing in the numbers but on most of the key national measures, U.S. consumers look little different than they did in 2004, or in 1998. That’s fascinating, sobering and humbling, because even with the benefit of hindsight it’s difficult to see the dangers ahead.

Here are some examples. The leverage ratio—the ratio of debt to assets—actually dropped somewhat from 2004 to 2007, going from 15% to 14.9%. By these numbers, overall households were actually better off in 2007 than in 2004.

Book1_21049_image001.gif

But in hindsight you can actually see the subprime problems taking hold in the data. In the early part of the decade, the leverage ratio rises for high school grads and people with some college. Then between 2004 and 2007 the leverage ratio for people without high school diplomas rose from 14% to 18.2%, as lenders reached down to people who would not have qualified in the past.

leverage_6468_image001.gif


Another example: The median holdings of debt, adjust for inflation, only rose from $60,700 to $67,000 from 2004 to 2007, a 10% increase. That’s not very much over a three years period. Two exceptions: Median debt for people without high school diplomas rose roughly 50%, while median debt for nonwhite or hispanic rose roughly 30%. Once again, signs of subprime issues.

Another example: The ratio of debt payments to family income only ticks up slightly, from 14.4% in 2004 to 14.5% in 2007. Both of those numbers are lower than the 14.9% in 1998. What’s more, the percentage of debtors with payments 60 days or more overdue actually fell from 8.9% in 2004 to 7.1% in 2007. On the other hand, the percentage of debtors paying out more than 40% of their income to service loans rose to 14.7%.

My conclusion: The ambiguity of these figures helps explain, a bit, why even smart people didn’t see this coming. I will give the link to the full Federal Reserve article after it is released this afternoon.

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Reader Comments

Wes

February 12, 2009 06:02 PM

It's important to consider that the crisis was not triggered from consumers. It was triggered by the reckless practices of banks and financial institutions, which resulted in huge losses once the housing bubble began to deflate. Hence the credit crisis

The hit on consumers was a result of the crisis (rather than a cause), although the high levels of consumer debt and the low savings rate made them especially vulnerable and thus amplified the overall economic effect of the credit crisis.

It can perhaps be argued that consumers have been vulnerable for many years and just needed some kind of "trigger" to bring down the house of cards.

Mike Reardon

February 12, 2009 07:58 PM

I’ll go with Wes on this.

If everything is seen as whole in the economy, the only things missing are orderly bank lending, secondary liquidity generation and investor buying into the process.

Even with the negatives of wage degeneration and consumer debt being added, the whole process was manageable until the bank event stopped lending after mid-year.

I don’t see this as a true recession going back into 2007 and caused by housing price degradation, but only a credit event centered in reaction to those effects within the leveraged debt markets. Housing was proportional but leverage debt was the monster that could not be unwound. Everything really was undone by that credit event and the banks stopping lending.

Viking

February 12, 2009 08:59 PM

Rather than looking at government surveys,which are usually suspect and prone to later revisions,I would look at house prices.Compare prices to affordability indexes and price to rent ratios,to see where prices are compared to long run averages.This would have clearly shown that house prices began to trend above the long run average around year 2000 and the extremely low interest rates following the tech bubble bursting,further added fuel to the fire.Then the invention of all the various mortgage products that allowed people with no credit and no down payment to get a home loan,was like throwing gasoline on a fire already out of control.So there were plenty of warning signs,but the people in a position to do something about it simply choose not to do so!!

CompEng

February 12, 2009 11:52 PM

Well, consumers did play a role, but the media spin has been that people spent beyond their means. They spent beyond their income, but not their assets. Now the asset bubble has deflated.
It all comes back to this: everybody knew there was a housing bubble, but they didn't really believe it, not as a macroeconomic event. And in an efficient economy with lots of fluidity, you just don't get "warnings" about structural corrections.

jcage

February 13, 2009 05:41 PM

Peter Schiff saw it coming
http://www.youtube.com/watch?v=2I0QN-FYkpw&feature=related

He also has some prediction on the future
http://www.youtube.com/watch?v=9h2x7R8pxUs&feature=related

Rycoka

February 17, 2009 11:42 PM

It strikes me that a 10% increase in the median level of debt over a three year period is something that should have caused alarm, especially if it came on top of a longer period of steadily increasing indebtedness (Australia's figures show a steadily increasing debt burden over two or three decades).
One issue that I haven't seen explored much yet is the relationship between the level of debt and central banks ability to control inflation via interest rates. Is it possible we got to the point where applying the interest rate brakes caused the wheels to fall off because the economy was rusted through with excessive debt?

LAO

February 18, 2009 11:54 AM

I keep trying and failing to prove the case based on the numbers, yet the excessive prices of homes in combination with stagnant wages seemed unsustainable. I have a feeling that the overlooked component is the makeup of household income -- a low-risk mortgage is one that can be sustained by either party alone in a 2-earner household, but home prices reached a level where this safe scenario was surely rare.

Earlier bankruptcy and foreclosure reports supported the notion that household tolerance of financial stress had been lost. We know that the churn in jobs has been tremendous, even while the unemployment rate was low. It stands to reason that sooner or later, untimely forced sales would bring down local home values and threaten those who depended upon appreciation to refinance their way out of timebomb mortgages.

Thank you for your interest. This blog is no longer active.

 

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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