Greenspan, before a gathering of the Credit Union National Association in Washington,
said decades of low interest rates and extra cash from refinancing have given
people flexibility to better manage their debt.
The Federal Reserve's own figures show that consumer debt hit a record $2 trillion
in December. That debt includes credit cards and car loans, but not mortgages.
More than 1.6 million people filed for personal bankruptcy in fiscal year 2003--a
7.8 percent increase and a continuation of the record-setting trend of the past
several years, according to the Associated Press.
Greenspan acknowledged that the trend is troubling because it shows the difficulties
some households experience during economic slowdowns. But he added that "bankruptcy
rates are not a reliable measure of the overall health of the household sector
because they do not tend to forecast general economic conditions and they can
be significantly influenced over time by changes in laws and lender practices."
Following are his prepared remarks for the conference, taken from the Fed's
Introduction: Credit Unions and Consumer Lending
Credit unions have long focused on the needs of their members. Traditionally,
the industry has specialized in personal and automobile loans, and the bulk
of lending at many credit unions remains concentrated on these types of loans.
In the past decade, however, many of you have become more involved in first-
and second-lien mortgage loans. With lending efforts focused on consumer and
residential mortgage loans, credit unions have a natural interest in the financial
health of America's households.
We have a similar interest at the Federal Reserve. Consumer spending accounts
for more than two-thirds of gross domestic product, and residential investment--the
construction of new homes--makes up another 4 percent or so of GDP. In addition,
households own more than $14 trillion in real estate assets, almost twice
the amount they own in mutual funds and directly hold in stocks. Over the
past two years, significant increases in the value of real estate assets have,
for some households, mitigated stock market losses and supported consumption.
Measuring the Financial Health of Households
One concern of many lending institutions has been the increase in bankruptcy
rates during the past several years to an unusually high level. Elevated bankruptcy
rates are troubling because they highlight the difficulties some households
experience during economic slowdowns. But bankruptcy rates are not a reliable
measure of the overall health of the household sector because they do not
tend to forecast general economic conditions, and they can be significantly
influenced over time by changes in laws and lender practices.
In contrast to bankruptcy rates, delinquency rates may be a bit better measure
of the overall health of the household sector. The recent experience with
some delinquency rates has been encouraging, with rates falling for several
measures of credit card and automobile debt. But, like bankruptcy rates, delinquency
rates can reflect changes in underwriting and collection practices, and they
may measure the financial health of a relatively narrow set of households.
A primary measure used by the Federal Reserve to assess the extent of American
household indebtedness and to provide a view of the financial health of the
overall consumer sector is the quarterly debt service ratio. The debt service
ratio measures the share of income committed by households for paying interest
and principal on their debt. When the debt service ratio is high, households
have less money available to purchase goods or services. In addition, households
with a high debt service ratio are more likely to default on their obligations
when they suffer adversity, such as job loss or illness.
Of course, debt payments are not the only financial obligations of households
and thus the Federal Reserve also calculates a more general financial obligations
ratio. This measure incorporates households' other recurring expenses, such
as rents, auto leases, homeowners' insurance and property taxes, that might
be subtracting from the uncommitted income available to households. The Federal
Reserve splits the aggregate financial obligations ratio into separate measures
for homeowners and renters, measures that I will discuss in detail below.
Changes in the Debt Service and Financial Obligation Ratios over Time
Both the debt service ratio and the financial obligations ratio rose modestly
over the 1990s. During the past two years, however, both ratios have been
essentially flat. The debt service ratio has remained a touch above 13 percent,
whereas the financial obligations ratio has hovered a bit above 18 percent.
These ratios move slowly because both the stock of debt and the interest
rates associated with the stock change slowly. Another reason is the stability
in the ratio for homeowners, who hold the bulk of all household debt. Despite
annual mortgage debt growth that exceeded 12 percent a year over the past
two years, the financial obligations of homeowners have stayed about constant
because mortgage rates have remained at historically low levels. The homeowners'
financial obligations ratio has also remained relatively constant despite
this very rapid growth in mortgage debt, partly as a result of an enormous
wave of refinancing of existing mortgages, which ended only in the fall of
2003. Refinancing has allowed homeowners both to take advantage of lower rates
to reduce their monthly payments and, in many cases, to extract some of the
built-up equity in their homes. These two effects seem to have roughly offset
each other, suggesting that homeowners might set a target for their mortgage
payments as a proportion of income and adjust their borrowing accordingly.
Indeed, the surge in mortgage refinancings likely improved rather than worsened
the financial condition of the average homeowner. Some of the equity extracted
through mortgage refinancing was used to pay down more expensive, non-tax-deductible
consumer debt or used to make purchases that would otherwise have been financed
by more expensive and less tax-favored credit. Indeed, the refinancing phenomenon
has very likely been a supportive factor for the general economy. The precise
effect is difficult to identify because it is hard to know how much of the
spending financed by home equity extraction might have taken place anyway.
Nonetheless, we know that increases in home values and the borrowing against
home equity likely helped cushion the effects of a declining stock market
during 2001 and 2002.
Rising Credit Card Debts for Homeowners and Renters
The rise in homeowners' debt service burdens over the 1990s, albeit small,
is associated with increases in their nonmortgage debt and, in particular,
with rising levels of credit card debt. The financial obligation associated
with credit card debt is difficult to measure. On the one hand, households
are obligated to pay only a minimum amount and thus, in times of financial
stress, a household can forgo making more than this minimum payment. On the
other hand, we know that many households make more than the minimum payment
and indeed likely would be quite uncomfortable paying only the minimum amount.
During financial difficulties, these households might even consume less to
pay more than the minimum. Defining the point at which households feel they
should pay down their credit card debt is difficult, and thus our measure
of debt service relies on estimates of minimum payments required by credit
There are several reasons that homeowners might carry more credit card debt
than they did a decade ago, but these reasons generally do not indicate financial
weakness among homeowning households. Indeed, as noted, delinquency rates
on credit card payments have been falling during the past year, despite households'
relatively larger holding of credit card debt.
One possible reason for the secular increase in credit card debt is rising
U.S. homeownership rates. According to the Bureau of the Census, the share
of U.S. households that own homes rose from about 64 percent in 1990 to almost
68 percent in 2003 even as the population grew substantially. Because of rising
incomes, lower interest rates, and increased rates of household formation,
more people have chosen to buy homes rather than to rent, increasing the value
of mortgages outstanding. Although it does not show the relationship conclusively,
the Federal Reserve's Survey of Consumer Finances suggests that these newer
homeowners who make smaller down payments tend to bring with them higher levels
of nonmortgage debt and, in particular, credit card debt. The ability of lending
institutions to manage the risks associated with mortgages that have high
loan-to-value ratios seems to have improved markedly over the past decade,
and thus the movement of renters into homeownership is generally to be applauded,
even if it causes our measures of debt service of homeowners to rise somewhat.
Another possible reason for rising credit card debt ratios is the use of
credit cards for a variety of new purposes. The rise in credit card debt in
the latter half of the 1990s is mirrored by a fall in unsecured personal loans.
Reflecting this general trend, the proportion of personal loans in credit
union portfolios has been declining as well. The wider availability of credit
cards and their ease of use have encouraged this substitution. The convenience
of credit cards also has caused homeowners to shift the payment for a variety
of expenditures to credit cards. In sum, credit card debt service ratios have
risen to some extent because households prefer credit cards as a method of
* * *
In contrast to the increase for homeowners, the rise in debt service ratios
was steep for renters in the latter half of the 1990s. The rise for renters,
as for homeowners, is concentrated in credit card lending and thus may reflect
some of the same factors that have influenced homeowner debt service ratios.
But unlike homeowners, renters in recent years have been using a higher fraction
of their incomes for payments on student loans and used-car debt. Renters
tend to be younger and have lower incomes than homeowners, so the fact that
student loans and used-car payments are a larger share of their income is
not surprising, although this trend might be worrisome if it indicates greater
difficulties in becoming financially established.
In addition, some of the rise in the debt service ratios of renters, unlike
that of homeowners, occurred during the most recent recession, a difference
highlighting the fact that incomes of renters are generally more at risk during
economic downturns. Renters' debt service ratios have stabilized during the
past two years, a hopeful sign that is likely correlated with the overall
improvement in the economy. However, the rise in the renter debt service ratio
might indicate some trends among these households that may be of concern and
that need to be investigated further.
Mitigating Homeowner Payment Shocks
Rising debt service ratios are a concern if they reflect household financial
stress and presage a drop in consumption or a rise in losses by lenders. Most
homeowners and renters are aware of the possible difficulties should they
lock themselves into a high level of debt payment obligations. Financial institutions
might be able to help some households in this regard by looking for ways that
households--both renters and homeowners--can shield themselves from unexpected
One way homeowners attempt to manage their payment risk is to use fixed-rate
mortgages, which typically allow homeowners to prepay their debt when interest
rates fall but do not involve an increase in payments when interest rates
rise. Homeowners pay a lot of money for the right to refinance and for the
insurance against increasing mortgage payments. Calculations by market analysts
of the "option adjusted spread" on mortgages suggest that the cost
of these benefits conferred by fixed-rate mortgages can range from 0.5 percent
to 1.2 percent, raising homeowners' annual after-tax mortgage payments by
several thousand dollars. Indeed, recent research within the Federal Reserve
suggests that many homeowners might have saved tens of thousands of dollars
had they held adjustable-rate mortgages rather than fixed-rate mortgages during
the past decade, though this would not have been the case, of course, had
interest rates trended sharply upward.
American homeowners clearly like the certainty of fixed mortgage payments.
This preference is in striking contrast to the situation in some other countries,
where adjustable-rate mortgages are far more common and where efforts to introduce
American-type fixed-rate mortgages generally have not been successful. Fixed-rate
mortgages seem unduly expensive to households in other countries. One possible
reason is that these mortgages effectively charge homeowners high fees for
protection against rising interest rates and for the right to refinance.
American consumers might benefit if lenders provided greater mortgage product
alternatives to the traditional fixed-rate mortgage. To the degree that households
are driven by fears of payment shocks but are willing to manage their own
interest rate risks, the traditional fixed-rate mortgage may be an expensive
method of financing a home.
In evaluating household debt burdens, one must remember that debt-to-income
ratios have been rising for at least a half century. With household assets
rising as well, the ratio of net worth to income is currently somewhat higher
than its long-run average. So long as financial intermediation continues to
expand, both household debt and assets are likely to rise faster than income.
Without an examination of what is happening to both assets and liabilities,
it is difficult to ascertain the true burden of debt service. Overall, the
household sector seems to be in good shape, and much of the apparent increase
in the household sector's debt ratios over the past decade reflects factors
that do not suggest increasing household financial stress. And, in fact, during
the past two years, debt service ratios have been stable.