Transcript Slide 1

Discussion of Campbell and Hercowitz’s
“Home Equity and Wealth During the Transition
to a High Debt Economy”
Erik Hurst
November 2006
Overview
•
Stylized Fact – Use of debt has increased dramatically in the U.S. during the
last two decades.
Overview
•
Stylized Fact – Use of debt has increased dramatically in the U.S. during the
last two decades.
•
My discussion:
-
Why should this be of interest to macroeconomists?
Overview
•
Stylized Fact – Use of debt has increased dramatically in the U.S. during the
last two decades.
•
My discussion:
-
Why should this be of interest to macroeconomists?
-
What are the potential causes for the increase in debt?
Overview
•
Stylized Fact – Use of debt has increased dramatically in the U.S. during the
last two decades.
•
My discussion:
-
Why should this be of interest to macroeconomists?
-
What are the potential causes for the increase in debt?
-
Can we learn anything about the causes of the increase of debt from time
series trends?
Overview
•
Stylized Fact – Use of debt has increased dramatically in the U.S. during the
last two decades.
•
My discussion:
-
Why should this be of interest to macroeconomists?
-
What are the potential causes for the increase in debt?
-
Can we learn anything about the causes of the increase of debt from time
series trends?
-
Throughout, I will discuss the contributions of the Campbell and
Hercowitz paper to this literature?
Part 1: Why Should (Macro) Economists Care?
An Explanation for “The Great Moderation”
1.
-
U.S. volatility was reduced dramatically starting around 1983 (see, for
example, Stock and Watson 2002).
-
Common explanations focus on either 1) better monetary policy, 2)
more favorable aggregate shocks, or 3) improvements in firm
management of inventories.
-
Given that consumption is the largest component of GDP, innovations in
the ability of consumers to weather aggregate shocks will mitigate
aggregate volatility.
Part 1: Why Should (Macro) Economists Care?
An Explanation for “The Great Moderation”
1.
-
U.S. volatility was reduced dramatically starting around 1983 (see, for
example, Stock and Watson 2002).
-
Common explanations focus on either 1) better monetary policy, 2)
more favorable aggregate shocks, or 3) improvements in firm
management of inventories.
-
Given that consumption is the largest component of GDP, innovations in
the ability of consumers to weather aggregate shocks will mitigate
aggregate volatility. (Behavior of consumption during last recession)
-
See recent work by Dynan et al (2006) and Campbell and Hercowitz
(2006) for novel discussions.
Why Should (Macro) Economists Care?
2.
Welfare Implications for Consumers (Including Sub Populations)
-
Not only smooth aggregate shocks, but better able to smooth
idiosyncratic shocks or predictable lifecycle variation.
-
The increase in debt likely helped some sub groups much more than
others. The median household likely always had some access to debt
(store cards, etc.).
-
Historically, low income households were essentially excluded from
credit market. May predict that the welfare gains would be largest for
low income individuals.
Why Should (Macro) Economists Care?
3.
Lower U.S. Savings Rates
-
Lower U.S. Investment?
-
Higher U.S. Interest Rates?
-
Increased Foreign Capital Inflows?
Note:
I will return to the declining U.S. savings rate in a few minutes.
4.
Increased Bankruptcy (Default) Probabilities
5.
Changing Wealth Inequality within U.S.
Part 2: Natural Question
•
What caused the sharp increase in debt (both collateralized and noncollateralized) among all groups of U.S. households during last
forty years?
- Supply side factors
- Demand side factors
Supply Side Factors: Legislation
•
Monetary Control Act: 1980
•
Garn-St. Germain Act: 1982
- Both of above increased the competitiveness in consumer lending
- Focus of the “shock” to credit market in this paper.
Supply Side Factors: Legislation
•
Monetary Control Act: 1980
•
Garn-St. Germain Act: 1982
- Both of above increased the competitiveness in consumer lending
- Focus of the “shock” to credit market in this paper.
•
Federal Housing Enterprises Financial Safety Act (Mandate Fannie and
Freddie better serve low income households): 1992
- Change the composition of borrowers in the average mortgage pool
•
Riegle-Neal Act (Interstate Banking): 1994
- Further increase competitiveness among banks
Supply Side Factors: Technology
Technological advances reduced the cost of providing financial services.
•
Computers: Allowed lenders to store large amounts of data about
perspective borrowers and, in doing so, allowed them to price borrower risk
more effectively.
-
Invention and use of FICO scores (1990-ish)
Reduced credit rationing
Bennett, Peach, and Peristiani “Structural Change in the
Mortgage Market and the Propensity to Refinance” (JMCB ‘01)
Supply Side Factors: Technology
Technological advances reduced the cost of providing financial services.
•
Computers: Allowed lenders to store large amounts of data about
perspective borrowers and, in doing so, allowed them to price borrower risk
more effectively.
-
Invention and use of FICO scores (1990-ish)
Reduced credit rationing
Bennett, Peach, and Peristiani “Structural Change in the
Mortgage Market and the Propensity to Refinance” (JMCB ‘01)
•
Securitization: Innovations and managing risk through pooling loan
portfolios (CMO’s, etc.). Increasingly important for non-collateralized
loans as well as high risk collateralized loans (early 1990s).
•
Endogenous to regulations?
Maybe/Maybe Not
Demand Side Factors
•
Aggregate Volatility Declining (Starting in 1983)
•
•
•
Declining volatility should result in declining precautionary savings.
Although, evidence suggests that for some groups individual income
volatility increased despite declining aggregate volatility.
Bankruptcy Option
•
•
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Decline in Bankruptcy Costs (stigma, information, out of pocket
expenses)
Increases in Bankruptcy Exemptions (1978 Bankruptcy Reform)
Equilibrium would have higher debt and higher defaults (coupled with
higher interest rates).
Summary
•
Lots of reasons why debt could have increased during the last 20 years.
- The role of technology (including the ability to credit score) and
securitization are likely an important component of the story.
- Along with changes in GSE’s policies, changed the mix of borrowers.
•
My read of the literature is that the innovations in lending occurred
continuously throughout this time period.
•
Cause of the increase in debt is important for interpreting the trends in
the aggregate data (and for interpreting the results from calibrated
models) .

Part 3: What is Campbell and Hercowitz About?
•
Sets out to ask what is the response to consumption, work hours, debt, the
wealth distribution, etc. from an exogenous increase in households’ ability to
accumulate collateralized debt.
•
Key: All borrowing in the economy is collateralized.
•
Extent of collateralization has two components:
-
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π is the required equity needed to purchase a durable (i.e., the down
payment).
 is the parameter that governs the speed of subsequent equity
accumulation (think of this as the ability to refinance).
•
Focuses on a shock in the early 1980s (financial deregulation) that
causes both π and  to change immediately.

Part 3: What is Campbell and Hercowitz About?
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Two types of households: “borrowers” and “savers”.
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Utility = f(durables, non-durables, and “leisure”)
•
The only reason “borrowers” accumulate debt within the model is
impatience (savers are relatively more patient)
•
Borrowers are always bound by the liquidity constraint in steady state.
•
Model is general equilibrium (wages and interest rates adjust; only
borrowers work)
•
Borrowers do no saving and savers do no borrowing. (All action in the
model is between the trade of resources between borrowers and
savers).

Part 3: What is Campbell and Hercowitz About?
Results from an exogenous decline in equity needed to purchase durables:
1)
“Savers better off” and “borrowers worse off” at the new steady state.
2)
Borrowers are worse off because – interest rates on debt increases, labor
supply increases, and wages fall.
-
3)
Why do borrowers increase debt? Welfare gains during transition!
Constraint is relaxed along the early part of the transition path –
borrowers can use current durables to expand current consumption.
Steady state wealth distribution becomes more unequal (borrowers go more
in debt and savers increase wealth via “loans”)

Part 4: A Look at the Data
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Trends in collateralized debt
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•
Trends in non-collateralized debt
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•
LTV’s for mortgages (initial equity requirement, π)
Refinancing behavior (speed of subsequent equity accumulation,  )
Levels
Access
Trends in wealth distribution
Loan-To-Value (LTV) Ratios At Time of Purchase
Data from SCF: Campbell and Hercowitz (Table 1)
86
84
82
Increase
80
78
76
74
72
1983
1989
1992
1995
1998
2001
• Notice that initial LTV is constant up through 1989
• Model predicts debt (LTV) should start to increase immediately
Historical LTV’s for New Mortgages
(Including Refi’s)
1983
Source: Federal Housing Finance Board
Increase starts ~ 1992
Some Facts: Homeownership Rates
1983
Source: Census Bureau
~ 1994
Refinancings Over Time
•
Define η as the elasticity of refinancing propensity with respect to interest
rate declines.
•
Research shows that η(2002) > η(1998) > η (1993) > η (1986)
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In other words, refinancing has continuously become more common over
time.
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Bennett et al (2001) attribute this to the continuous decline in the cost of
originating a mortgage.
Understanding The Role of Debt in the Macroeconomy
Initial Fees and Charges on Conventional Single-Family Mortgages
1983
Notice Stead Decline
Note the Steady Decline
Source: Federal Housing Finance Board
Non-Collateralized Debt Per Capita/Per Income
Figure 1: Consumer debt in the US, 1960 = 100
400
350
debt per capita
debt/income ratio
300
250
200
150
100
50
1960 1964 1968 1972
1976 1980 1984 1988
1992 1996 2000 2004
Access to Non Collateralized Credit
Credit Card Access by Income Quintile by Year (fraction with card)
Quintile
1970
1983
1989
1995
Q1
Q2
Q3
Q4
Q5
2%
9%
14%
22%
33%
11%
27%
41%
57%
79%
17%
36%
62%
76%
89%
28%
54%
71%
83%
95%
Source:
Note:
Durkin (2000)
Trend continues since 1970.
Access to Non Collateralized Credit
Credit Card Access by Income Quintile by Year (fraction with card)
Quintile
1970
1983
1989
1995
Q1
Q2
Q3
Q4
Q5
2%
9%
14%
22%
33%
11%
27%
41%
57%
79%
17%
36%
62%
76%
89%
28%
54%
71%
83%
95%
Source:
Note:
Durkin (2000)
Look at the Trend starting in 1970.
Share of Wealth Held By Top 10%
1990
Figure 2 from Campbell and Hercowitz
Share of Housing Held By Top 10%
1990
1990
Figure 2 from Campbell and Hercowitz
Mortgage Debt/Owner Occupied Real Estate
50.0
1983
1990
45.0
40.0
Steady increase starting
around 1985
35.0
30.0
20
03
20
01
19
99
19
97
19
95
19
93
19
91
19
89
19
87
19
85
19
83
19
81
19
79
19
77
19
75
25.0
Comment 1: Measuring the Shock
Are the legislative changes in the early 1980s the appropriate shock to
calibrate the model?
•
For some analyzes, the distinction is not important.
However, this paper’s focus (and interpretation of results) hinge on the
transition dynamics.
Comment 1: Measuring the Shock
Are the legislative changes in the early 1980s the appropriate shock to
calibrate the model?
-
For some analyzes, the distinction is not important.
However, this paper’s focus (and interpretation of results) hinge on the
transition dynamics.
•
-
How can transition dynamics be isolated from subsequent shocks to
lending technology or lending competition?
Comment 1: Measuring the Shock
Are the legislative changes in the early 1980s the appropriate shock to
calibrate the model?
-
However, this paper’s focus (and interpretation of results) hinge on the
transition dynamics.
•
-
-
•
•
For some analyzes, the distinction is not important.
How can transition dynamics be isolated from subsequent shocks to
lending technology or lending competition?
Data shows that most of the lending measures (LTV, Debt to Income,
credit card debt) did not substantially change until the early 1990s or
continuously evolved over the period?
Timing of shock is important for interpreting magnitudes.
Timing of shock is important for testing model predictions.
Comment 1: Measuring the Shock
•
Even if we believe qualitative results and the timing of only one shock,
do quantitative magnitudes make sense given the data?
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Model estimates that the liquidity constraint re-binds for borrowers after
30 quarters (7 years). Yet most of the action does not take place on the
borrowing side until after 1990?
If successive shocks were hitting the economy, how do we interpret the
model parameters? The imputed welfare gains?
•
Understanding the origins of the shock is important for shaping future
policy recommendations. Is it deregulation or computers?
•
Question: Can you estimate the model where the lending technology is
evolving (perhaps at some constant rate) over the last twenty years?
Comment 2: Other Motives for Accumulating Debt
•
Other potential reasons households accumulate debt:
1) To smooth idiosyncratic labor risk
2) To smooth predictable income changes over the lifecycle.
3) To smooth aggregate shocks.
Comment 2: Other Motives for Accumulating Debt
•
Other potential reasons households accumulate debt:
1) To smooth idiosyncratic labor risk
2) To smooth predictable income changes over the lifecycle.
3) To smooth aggregate shocks.
•
Welfare gains from smoothing income could be huge.
-
Borrowers could be better off even in the new steady state
Only reason borrowers accumulate debt in this model is ‘impatience’.
Comment 2: Other Motives for Accumulating Debt
•
Other reasons households accumulate debt:
1) To smooth idiosyncratic labor risk
2) To smooth predictable income changes over the lifecycle.
3) To smooth aggregate shocks.
•
Welfare gains from smoothing income could be huge.
-
Borrowers could be better off even in the new steady state
Only reason borrowers accumulate debt in this model is ‘impatience’.
•
To provide quantitative results for policy purposes, it would be important to
model other reasons to accumulate debt besides impatience.
•
Question: Why not set up an OLG lifecycle analysis? What about the
role for non-collateralized debt?
Comment 3: Testing the Mechanism
Sharp decline in U.S. savings rate
(From Figure 1 of Maki and Palumbo, 2001)
1983
1992
Comment 3: Testing the Mechanism
•
Savings rates by income quintiles (Table 2 from Maki and Palumbo, 2001)
Comment 3: Testing the Mechanism
•
Savings rates by income quintiles (Table 2 from Maki and Palumbo, 2001)
Comment 3: Testing the Mechanism
•
Savings rates by income quintiles (Table 2 from Maki and Palumbo, 2001)
Comment 3: Testing the Mechanism
•
Contribution to aggregate savings rates for each income quintiles (Table 4
from Maki and Palumbo, 2001)
Comment 3: Testing the Mechanism
•
What would your model predict about the savings rates for borrowers
and savers during this time period?
•
Would they match the aggregate data?
•
My guess is no – what does that imply? Should we think about the
foreign sector being the “savers”? Does your model match foreign
inflows into the U.S.?
•
Why are rich U.S. households decreasing their savings rate so much?
•
Question: Could your model predict an increase in returns that would
generate the rich decreasing their savings and increasing their wealth
(at the same time that the poor increased their savings and increased
their wealth?)
Conclusions
•
The expansion of debt (both collateralized and non-collateralized)
should be an important area of research for macroeconomists.
•
I applaud the authors for working on this topic!
•
For their research agenda (in both this paper and the previous paper)
which employs calibrated GE models – it is important to model the
“shock” to lending correctly.
•
To gauge welfare gains from expansion to credit, it would be good to
include more realistic demands for borrowing (e.g., life cycle model with
idiosyncratic labor income risk).
•
I would put their mechanism to the test and see how it does at matching
the trends in saving rates for “borrowers” and “savers” (as well as the
aggregate).