The historically slow recovery of the economy and lack of substantial job growth could cause negative, lasting effects on the current young generation and force many retirement age individuals to remain in the workforce, according to a study released by the Mortgage Bankers Association (MBA). The impact of a higher unemployment rate for Americans aged 16-24 could have a lasting effect on lifetime earnings and attitudes toward risk and social policies. In addition, those nearing retirement are delaying retirement and reentering the labor force in an effort to rebuild some of the retirement wealth that was wiped out by the recession.
The study, "Household Reaction to the Financial Crisis: Scared or Scarred?," conducted by Professor Joe Peek, Gatton Endowed Chair in International Banking and Financial Economics at the University of Kentucky and sponsored by the Research Institute for Housing America (RIHA), analyzes how Americans will respond to the current crisis in terms of consumer spending, saving rates, credit supply and implications for the strength of the economic recovery.
"While Americans, and the American economy, are noted for their resilience, the current financial crisis and recession exceeded the devastation created by other post-World War II recessions," said Peek. "Saving rates have risen substantially and many Americans will continue to cut their spending sharply out of necessity, others out of fear of what the future holds. Since consumer expenditures account for about two-thirds of GDP, we are facing the "paradox of thrift" as households try to rebuild their net worth, with the reduced spending likely to delay and weaken the recovery from the 'Great Recession'."
"On the housing front, it is unlikely that the dramatic rise in loan delinquencies, home foreclosures and bankruptcies will show a meaningful decrease, as high unemployment and low house prices are widely projected to remain for an extended period, as well as the rise in problem loans at banks that will restrain their willingness and ability to provide credit," said Peek. "Unfortunately, we face the possibility of being caught in a vicious circle. The cutbacks in consumer and business spending are likely to contribute to a more anemic recovery. In turn, we will likely see a deepened and prolonged weakness in consumer and business spending, further undermining the recovery. The longer the malaise in economic activity continues, the more likely that diminished spending persists, adversely affecting future economic growth and the standard of living. Such headwinds to a strong economic recovery are likely to have lasting impacts on the values and behavior of the current generation, much as the Great Depression had on its generation."
Michael Fratantoni, MBA's vice president of research and economics, said, "The severity and duration of the most recent downturn far exceeds what we have experienced in past recessions and has resulted in the disruption of millions of lives. We can't know for certain at this point, but it is more than reasonable to prepare for a world that has been irrevocably changed by this experience. For the many reasons discussed in this study, we should expect hesitant homebuyers, cautious businesses, and conservative lenders in the years ahead."
Key findings from the study include:
►For U.S. data, most estimates of the wealth effect (propensity to consume out of total household wealth) are in the range of .3 to .8 cents of an additional dollar of wealth. This wealth effect is now operating in reverse, with losses in housing and other wealth resulting in reduced consumer spending.
►The downtrend in the personal saving rate over the past twenty years has been reversed. The saving rate rebound is likely related to the large capital losses on household assets, as well as a precautionary motive in response to increased uncertainty.
►Underemployment is much higher than the reported unemployment rate, and the persistence of spells of unemployment are lengthening. Many are delaying retirement in an effort to rebuild retirement nest eggs. Firms are shifting from permanent employees with benefits to part-time, temporary and independent contract employees.
►People entering the labor force during recessions have lower lifetime incomes. Those unable to find work today are going to be competing with a new crop of graduates in a few months for a still limited set of job openings. Without a reasonably rapid recovery in employment, at this point an unlikely scenario, we risk creating a "lost generation" that may never catch up.
►Credit supply as well as credit demand have been impacted by the financial crisis, as well as by government programs to support financial markets and the housing sector. Banks remain in weak financial health, and thus are unlikely to increase credit supply by a substantial amount in the near term. Many households will emerge from this crisis with severely damaged credit ratings, hindering their ability to access credit for years to come.
►Credit underwriting and pricing models developed with data from years prior to this crisis were heavily influenced by our experience with moderate macroeconomic volatility; this downturn will likely play an outsized role in credit decisions over the intermediate term.
To obtain a copy of the report, visit the RIHA website www.housingamerica.org.