Tag: USA

Wall Street landlords are chasing the American dream

From The Conversation.

Owning a family home in the suburbs has been a cornerstone of the American dream for many generations. But in 2008, when the United States’ housing bubble burst and a spate of mortgage foreclosures triggered the global financial crisis, that dream was vanquished, and such houses would instead become the sites of shattered lives.

In the aftermath of the crisis, hundreds of thousands of suburban homes were repossessed and sold at auction. With the market in shambles, prices were low. Tightened credit made it hard for individuals to buy – even for those whose credit was not destroyed by the crisis. Investors saw an opportunity, and began buying up houses.

Though house prices have recovered in many regions of the US, many of the people living in these homes are now renting – and their landlords are some of the biggest investment firms on Wall Street. Of course, small scale, mostly local investors have long owned and rented out individual houses. But it simply wasn’t feasible to manage large numbers of individual homes at a distance. As technology changed, it became much more practical for large corporations to manage individual homes spread across different regions.

With access to credit and funds unavailable to the average home buyer, large investors have been able to enter the landlord market in ways that have never been seen before. Blackstone – the world’s largest alternative investment firm – pioneered new rent-backed financial instruments in 2013, whereby rent checks are bundled up and sold as securities, similar to the way that mortgage payments are turned into financial products bought by investors.

Now, Blackstone’s rental company Invitation Homes looks set to merge with Starwood Waypoint Homes; a move that would create the nation’s largest landlord, with roughly 82,000 homes across the country. Another Wall Street backed firm, American Homes 4 Rent, owns a further 49,000 homes across 22 states.

Renting the American dream

Since 2010, the United States has seen a massive rise in the number of families renting the kind of single-family houses that have long been the desire of would-be homeowners chasing the American dream. While estimates vary, the inventory of single family homes being rented has grown by anywhere from three to seven million (35% to 67%) compared with pre-crisis levels. Single-family houses are now the most common form of rental property in the United States.

Overwhelmingly, the people living in these houses are families. Our ongoing research with Jake Wegmann of the University of Texas and Deirdre Pfeiffer of Arizona State University shows that almost half of Single Family Rented (SFR) households (49%) have at least one child under 18; a far greater percentage than rental properties with multiple units (roughly 25%) and owner-occupied homes (31%).

According to our own analysis of the American Community Survey, in 2015 an estimated 14.5m children in the United States lived in a rented single-family home. Demographically, single-family renters are more likely than owners to be people of colour, and to face moderate or severe housing cost burdens. The upshot of all this is that the 40m or so people living in SFR homes now form the basis of a new asset class of rental-backed securities.

Destination unknown

Scaling up portfolios consisting of thousands or tens of thousands of rental homes has made it possible for Wall Street firms to roll out financial instruments suited to “a rentership society”. Securitisation allows big investors to borrow against the value of the properties, to buy more properties and pay off old debt, and acts as a loan that tenants pay back with their rent checks.

Wall Street is no stranger to the housing business in America. But their involvement as landlords of single-family homes is new, and so are the financial instruments they have developed. The impact of Wall Street’s new role is unclear. While rehabilitating houses and helping to stabilise home values in the hardest-hit markets, they may also be crowding out first-time buyers, creating a lopsided market that shuts out would-be owner-occupiers.

Some Wall Street landlords have been singled out for poor repairs, problems with billing and collections and lacklustre customer service. There is also growing concern about the fact that renters of single-family homes have little protection, even in cities with some form of rent control. A report from the Federal Reserve Bank of Atlanta found that large corporate owners of houses are more likely than smaller landlords to evict tenants; some filed eviction notices on up to a third of their renters in just one year.

Here to stay

Wall Street landlords are also making new political allies, hinting they intend to stick around. The largest single-family rental companies have banded together to form a trade group, the National Rental Home Council, which promotes large-scale, single-family rental housing and advocates for public policies friendly to their interests. And it seems to be working.

In an unprecedented move, just after President Trump’s inauguration, the government-backed mortgage agency, Fannie Mae, agreed to underwrite Blackstone’s initial public offering of Invitation Homes stock, to the tune of a billion dollars. Blackstone’s CEO is Steve Schwarzman, one of the president’s most loyal backers. And Thomas Barrack – the recently departed leader of Colony Starwood Homes, which is preparing to merge with Invitation Homes – is a longtime friend of the mogul-turned-president.

Meanwhile, another government-backed agency, Freddie Mac, has announced that it too was supporting investment in single-family rentals, but with a focus on financing for mid-size investors and with an explicit goal of maintaining rental affordability. Non-partisan organisations like the Urban Institute have also suggested that government-backed financing opportunities could help single-family rental serve as a new affordable housing strategy.

All of these developments suggest that the downward trend in home ownership after the financial crisis could be here to stay. And while there is nothing wrong with renting – just as there is nothing inherently good about owning – the changes we are seeing in the single-family rental market bear ongoing scrutiny, to ensure that Wall Street’s demand for profit does not once again wreak havoc on Main Street.

Authors: Desiree Fields, Lecturer in Urban Geography, University of Sheffield; Alex Schafran, Lecturer in Urban Geography, University of Leeds; Zac Taylor, PhD Candidate in Geography, University of Leeds

A very low VIX Index weighs against a higher bond default rate

From Moody’s.

The state of the US equity market also helps to give direction to the bond default rate. A well-functioning equity market helps to assure ample liquidity. In the extreme case of infinite liquidity, defaults would be nonexistent.

To the degree business assets are attractively priced, financially-stressed firms will find it easier to obtain relief via injections of common equity capital. For example, firms can secure more cash through the divestment of business assets when equity markets thrive.

Thus, the record shows that the moving 12-month average of the VIX index tends to lead the high-yield default rate. Recently, the VIX index’s moving 12-month average sank to a record low 12.2 points.

As inferred from their long-term statistical relationship, if the VIX index’s yearlong average remains under 13.25 points, the default rate is likely to dip under 2%. It may be premature to consider the possibility of a rising default rate until the VIX index’s unprecedented slide is reversed.

US Employment Data Weaker Than Expected

More weaker than expected economic data from the US. Total nonfarm payroll employment increased by 156,000 in August, and the unemployment rate was little changed at 4.4 percent, says the U.S. Bureau of Labor Statistics. The jobs growth was lower than the 186,000 consensus expectation. More evidence supporting the lower for longer interest rate hypothesis.

The number of long-term unemployed (those jobless for 27 weeks or more) was essentially unchanged in August at 1.7 million and accounted for 24.7 percent of the unemployed.

The labor force participation rate, at 62.9 percent, was unchanged in August and has shown little movement on net over the past year. The employment-population ratio, at 60.1 percent, was little changed over the month and thus far this year.

In August, average hourly earnings for all employees on private nonfarm payrolls rose by 3 cents to $26.39, after rising by 9 cents in July. Over the past 12 months, average hourly earnings have increased by 65 cents, or 2.5 percent. In August, average hourly earnings of private-sector production and nonsupervisory employees increased by 4 cents to $22.12.

The change in total nonfarm payroll employment for June was revised down from +231,000 to +210,000, and the change for July was revised down from +209,000 to +189,000. With these revisions, employment gains in June and July combined were 41,000 less than previously reported. (Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.) After revisions, job gains have averaged 185,000 per month over the past 3 months.

Low US Inflation Signals Interest Rates Will Remain Lower For Longer

The latest data from the US which shows low inflation and wage growth has pulled the implied forward interest rates down suggesting the Fed will hold rates lower for longer.  This is reflected in falling yields on the T10.

Nearly half of the “Trump Effect” repricing has been undone.

This is also flowing into lower rates in the international capital markets, which is translating to lower costs of funds for the Australian banks (one reason why Westpac has cut their fixed rates).

As a result, in our default model, we have reduced the likelihood of an interest rate rise for mortgage holders in Australia over the next few months. This will translate to a projected fall in defaults, despite rising mortgage stress. We will publish the August data on Monday.  Households are likely to be able to muddle through and the RBA will hope business investment, which was stronger this time, works through.

Meantime, here is interesting commentary from Moody’s on the US, who highlight that the latest drop by personal savings in the US brings attention to the financial stress now facing many households there.

The recent slowdown by the underlying rate of consumer price inflation significantly lowered the risk of a disruptive climb by interest rates. In response, the VIX index sank from the 16.0 points of August 10, 2017 to a recent 10.7 points, while a composite high-yield bond spread narrowed from August 11’s 410 bp to August 30’s 399 bp.

However, the narrowing by the high-yield bond spread has been limited by a climb by the average high yield EDF (expected default frequency) metric from the July 2017 average of 3.9% to the 4.4% average of the five-days-ended August 30. Moreover, the US high-yield credit rating revisions of the third-quarter todate show downgrades topping upgrades even after excluding rating changes that were not primarily driven by fundamentals.

As recently as early July 2017, the Blue Chip consensus had anticipated a 2.5% average for Q3-2017’s 10-year Treasury yield. Much to the contrary, the 10-year Treasury yield has averaged 2.26% thus far in the third quarter, including a recent 2.13%. Not even a widely anticipated September 2017 start to the Fed’s reduced reinvestment of maturing bonds has been capable of lifting Treasury bond yields demonstrably.

In addition to July’s 1.4% annual rate of core PCE price index inflation, benchmark bond yields have been reined in by the market’s much reduced expectation of another Fed rate hike for 2017. As of mid-day on August 31, the futures market implicitly assigned only a 36.4% likelihood to fed funds’ midpoint finishing 2017 at something greater than its current 1.125% according to the CME Group’s FedWatch tool.

By itself, core PCE price index inflation’s performance of the last 20 years suggests that the FOMC may have considerable difficulty as far as sustaining PCE price index inflation at 2% or higher. For the 20-years-ended June 2017, core PCE price index inflation averaged only 1.7% annually. The annual rate of core PCE price index inflation was at least 2% in only 58, or 24.2%, of the last 240 months (20 years).

For those months showing an annual rate of core PCE price index inflation of at least 2%, the average annual rate of core inflation was only 2.2%, wherein the fastest annual rate of core inflation was the 2.5% of August 2006.

Drop by personal savings curbs core inflation

The slower growth of wage and salary income has helped to contain price inflation. After decelerating from 2014’s 5.6% and 2015’s 5.5% to 2016’s 3.0%, the annual increase of private-sector wages and salaries approximated a still sluggish 3.1% during January-July 2017. In response to the pronounced slowdown by wages and salaries, personal savings have shrunk by -29% annually thus far in 2017 following yearlong 2016’s -18% plunge.

The drop by the ratio of personal savings to disposable personal income from its 6.1% average of the five years ended 2015 to the 3.8% of 2017 to date implies Americans lack the financial wherewithal to either support or absorb significantly higher prices for long.

High rates of personal savings make it easier for consumers to absorb higher prices. When core PCE price index inflation averaged 6.4% during 1970-1981, the personal savings rate averaged 11.7%. By contrast, the averages for January-July 2017 showed a much lower 3.8% personal savings rate and a much slower 1.6% annual rate of core PCE price index inflation.

In addition, the latest drop by personal savings brings attention to the financial stress now facing many US households. Today’s more unequal distribution of income implies that a relatively greater number of today’s households save little, if any, of their after-tax income. When confronted with higher prices, these “paycheck-to-paycheck” consumers will be compelled to eventually curtail real spending at the expense of business pricing power.

Federal Reserve Board Proposes to Produce Three New Reference Rates

Given questions about the transparency of the U.S. dollar LIBOR rate benchmark, and the quest for a more robust alternative, the US Federal Reserve Board has requested public comment on a proposal for the Federal Reserve Bank of New York, in cooperation with the Office of Financial Research, to produce three new reference rates based on overnight repurchase agreement (repo) transactions secured by Treasuries.

The most comprehensive of the rates, to be called the Secured Overnight Financing Rate (SOFR), would be a broad measure of overnight Treasury financing transactions and was selected by the Alternative Reference Rates Committee as its recommended alternative to U.S. dollar LIBOR. SOFR would include tri-party repo data from Bank of New York Mellon (BNYM) and cleared bilateral and GCF Repo data from the Depository Trust & Clearing Corporation (DTCC).

“SOFR will be derived from the deepest, most resilient funding market in the United States. As such, it represents a robust rate that will support U.S. financial stability,” said Federal Reserve Board Governor Jerome H. Powell.

Another proposed rate, to be called the Tri-party General Collateral Rate (TGCR) would be based solely on triparty repo data from BNYM. The final rate, to be called the Broad General Collateral Rate (BGCR) would be based on the triparty repo data from BNYM and cleared GCF Repo data from DTCC.

The three interest rates will be constructed to reflect the cost of short-term secured borrowing in highly liquid and robust markets. Because these rates are based on transactions secured by U.S. Treasury securities, they are essentially risk-free, providing a valuable benchmark for market participants to use in financial transactions.

Comments on the proposal to produce the three rates are requested within 60 days of publication in the Federal Register, which is expected shortly.

US Housing Bubble 2.0: Number Of Homebuyers Putting Less Than 10% Down Soars To 7-Year High

From Zero Hedge.

A really long, long time ago, well before most of today’s wall street analysts made it through puberty, the entire international financial system almost collapsed courtesy of a mortgage lending bubble that allowed anyone with a pulse to finance over 100% of a home’s purchase price…with pretty much no questions asked.

And while the millennial titans of high finance today may consider a decade-old case study on mortgage finance to be about as useful as a Mark Twain novel when it comes to underwriting mortgage risk, they may want to considered at least taking a look at the ancient finance scrolls from 2009 before gleefully repeating the sins of their forefathers.

Alas, it may be too late.  As Black Knight Financial Services points out, down payments, the very thing that is supposed to deter rampant housing speculation by forcing buyers to have ‘skin in the game’, are once again disappearing from the mortgage market.  In fact, just in the last 12 months, 1.5 million borrowers have purchased a home with less than 10% down, a 7-year high.

Over the past 12 months, 1.5M borrowers have purchased a home by putting down less than 10 percent, which is close to a seven-year high in low down payment purchase volumes

– The increase is primarily a function of the overall growth in purchase lending, but, after nearly four consecutive years of declines, low down payment loans have ticked upwards in market share over the past 18 months

– Looking back historically, we see that half of all low down payment lending (less than 10 percent down) in 2005-2006 involved piggyback second liens rather than a single high LTV first lien mortgage

– The low down payment market share actually rose through 2010 as the GSEs and portfolio lenders pulled back, the PLS market dried up, and FHA lending buoyed the purchase market as a whole

– The FHA/VA share of purchase lending rose from less than 10 percent during 2005-2006 to nearly 50 percent in 2010

– As the market normalized and other lenders returned, the share of low-down payment lending declined consistent with a drop in the FHA/VA share of the purchase market

On the bright side, at least Yellen’s interest rate bubble means that today’s housing speculators don’t even have to rely on introductory teaser rates to finance their McMansions...Yellen just artificially set the 30-year fixed rate at the 2007 ARM teaser rate…it’s just much easier this way.

“The increase is primarily a function of the overall growth in purchase lending, but, after nearly four consecutive years of declines, low down payment loans have ticked upward in market share over the past 18 months as well,” said Ben Graboske, executive vice president at Black Knight Data & Analytics, in a recent note. “In fact, they now account for nearly 40 percent of all purchase lending.”

At that time half of all low down payment loans being made involved second loans, commonly known as “piggyback loans,” but today’s mortgages are largely single, first liens, Graboske noted.

The loans of the past were also far riskier – mostly adjustable-rate mortgages, which, according to the Black Knight report, are virtually nonexistent among low down payment mortgages today. Instead, most are fixed rate. Credit scores of borrowers taking out these loans today are also about 50 points higher than those between 2004 and 2007.

Finally, on another bright note, tax payers are just taking all the risk upfront this time around…no sense letting the banks take the risk while pretending that taxpayers aren’t on the hook for their poor decisions…again, it’s just easier this way.

US Firms Coy About Borrowing More

From Moody’s

Comparatively thin high-yield bond spreads complement an increased willingness by banks to supply credit to businesses. The increased willingness to make business loans owes much to a benign outlook for defaults.

According to the Fed’s latest survey of senior bank loan officers, the net percent of banks tightening business — or commercial & industrial (C&I) — loan standards dipped from the +2.2 percentage point average of the four-quarters-ending with Q2- 2017 to the -3.9 points of Q3-2017. Moreover, the net percent of banks widening interest-rate spreads on new business loans plunged from the -7.9 percentage point average of the year-ended Q2-2017 to Q3-2017’s -21.1 points.

Though banks are more willing to lend to businesses, the business sector’s demand for C&I loans has receded. The same Fed survey of senior bank loan officers also found that the net percent of banks reporting a stronger demand for C&I loans from business customers sank from the -2.1 percentage-point average of the year-ended June 2017 to Q3-2017’s -11.8 points, which was the lowest quarter-long score since Q4-2011’s -15.7 points. However, Q4-2011’s reading followed a string of strong results as shown by the +14.9-point average of yearlong 2011.

By contrast, as of Q3-2017, the yearlong average of the net percent of banks reporting a stronger demand for C&I loans from business customers dropped to -6.2 points for its lowest such average since the -9.5 points of yearlong 2010. (Figure 3.)

Business borrowing says cycle upturn is past its prime

It is worth noting how the latest slide by the business-sector’s demand for C&I loans has occurred more than four years following a recession. In the context of a mature business cycle upturn, the yearlong average of the net percent of banks reporting a stronger demand for C&I loans previously sank to the -6.2 points of the span-ended Q3-2017 in Q2-2007 and Q4-2000.

Recessions materialized within 12 months of the previous two comparable drops by the business sector’s demand for bank credit. Granted the US may stay clear of a recession well into 2018, but the reality is that the current business cycle upturn is showing signs of age. Thus, the upside for interest rates is limited, especially if the annual, or year-to-year, rate of core PCE price index inflation stays under 2%. (Figure 4.)

A pronounced slowing by the annual growth rate of outstanding bank C&I loans from Q2-2016’s 10.2% surge to Q2-2017’s 2.2% rise is in keeping with a softer demand for C&I loans by business borrowers. However, the pace of newly rated bank loan programs from high-yield issuers tells a much different story.

After surging by 140.2% in Q1-2017 from Q1-2016’s depressed pace, the annual increase of new high-yield bank loan programs slowed to 2.1% in Q2-2017. Nonetheless, recent activity suggests the year-over-year growth rate for new high-yield bank loan programs will accelerate to roughly 16% during 2017’s third quarter. Support for this view comes from July 2017’s $52.4 billion of new bank loan programs from high-yield issuers that more than doubled the $24.1 billion of July 2016.

Lately, the growth of high-yield bank loan programs has been powered by refinancings of outstanding debt and the funding of acquisitions. Today’s relative ease of refinancing outstanding debt at easier terms highlights ample systemic liquidity, which will help suppress the incidence of default. Abundant liquidity also facilitates the take-over of weaker, default prone businesses by financially stronger entities. (Figure 5.)

Wells Fargo’s Auto Insurance Practices

From Moody’s

Last Thursday, Wells Fargo & Company announced an $80 million remediation plan for auto loan customers that it had incorrectly charged for collateral protection insurance (CPI) between 2012 and 2017. The announcement is credit negative for Wells Fargo. The remediation costs are relatively immaterial at approximately 1% of its pre-tax quarterly earnings, but the announcement is yet another negative reputational headline for the bank. Despite the limited financial effect, we expect that the announcement will exacerbate the damage to Wells Fargo’s reputation in this past year.

Wells Fargo requires auto loan customers to maintain comprehensive and collision insurance for financed autos during the term of the loan. The bank’s CPI program purchased auto insurance on the customer’s behalf from a third party if proof of auto insurance had not been provided. Wells Fargo’s review of its CPI program and related third-party vendor practices, which began in July 2016 and was prompted by customer concerns, found that approximately 570,000 customers may have been negatively and incorrectly affected.

Roughly 490,000 customers were incorrectly charged for CPI despite having satisfactory auto insurance of their own. Approximately 60,000 customers did not receive adequate notification and disclosure information from the vendor before the bank’s purchase of CPI on their behalf. Finally, for 20,000 customers, the required payments for the incorrectly placed CPI may have contributed to the default of their loan and repossession of their vehicle. Wells Fargo’s $80 million remediation plan intends to rectify financial harm to these customers. As a result of its initial findings, Wells Fargo discontinued its CPI program in September 2016.

Wells Fargo historically had strong customer satisfaction scores and a reputation for sound risk management. In September 2016, its lead bank subsidiary agreed to pay $185 million to federal regulators and the Office of the Los Angeles, California, City Attorney to settle sales practice issues. The settlement revealed that Wells Fargo’s retail banking incentive structure had led to pervasive inappropriate sales practices. The fallout from revealing the sales practices deficiencies resulted in a hit to Wells Fargo’s customer loyalty measure, shown in the exhibit below. Although the metric has improved from its fourthquarter 2016 low, the latest announcement could add pressure. However, on the positive side, there has been no significant sign of client attrition, despite the negative effect on customer loyalty metrics.

Furthermore, any resulting regulatory investigations, lawsuits or political inquiries could add to the bank’s costs, particularly for litigation. In particular, we have previously noted that the high end of Wells Fargo’s range for reasonably possible potential litigation losses in excess of its established liability was $2.0 billion at the end of the first quarter, up from $1.8 billion at year-end 2016 and $1.3 billion at year-end 2015. On the bank’s second-quarter earnings call, before this announcement, management indicated the high end of this range could grow by another $1.3 billion. Although these potential litigation costs are manageable given Wells Fargo’s robust pre-tax earnings, this recent announcement adds to profitability challenges the bank continues to face.

Fed Holds Rate, Confirms Intent

The latest statement from the FED says the US economic momentum continues, if but slowly. Inflation and income remains on the low side. So they kept the fed funds rate at current levels, but signalled continued future rises. Balance sheet normalisation has yet to start, but says it will commence.

U.S. stocks closed higher, buoyed by strong earnings and the Feds decision.

Information received since the Federal Open Market Committee met in June indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have been solid, on average, since the beginning of the year, and the unemployment rate has declined. Household spending and business fixed investment have continued to expand. On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

For the time being, the Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated; this program is described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans.

 

Understanding Banking from the Ground Up

From The St. Louis Fed On The Economy Blog.

Weak U.S. family balance sheets have driven more Americans to the “fringe” of the American banking system. But is this necessarily a bad thing?

The Federal Reserve’s Board of Governors recently released a shocking report showing that, if confronted with an unanticipated $400 expense, nearly half (44 percent) of Americans would have to sell something, borrow or simply not pay at all.1

Other surveys have been equally concerning:

This balance sheet fragility, especially illiquidity, is fueling the demand among Americans—and clearly, as the above data suggest, among middle-class Americans—for “alternative” financial services, including those from payday lenders, auto title lenders, check cashers and the like.

But should we be too critical of their financial choices? Is patronizing an alternative provider necessarily a poor or irrational choice? And do we ban payday lenders and the like because of annual percentage rates that are often in excess of 300 percent?

A Conversation with Lisa Servon on Unbanking

I wrestled with these questions following a recent St. Louis Fed event titled “The Banking and Unbanking of America”—featuring Lisa Servon, author of The Unbanking of America: How the New Middle Class Survives—and I think the answer to these questions is no.

Servon wondered: If these services are so bad, why have check-cashing transactions grown 30 percent between 1990 and 2010 while payday lending transactions tripled between 2000 and 2010?

According to Servon, it turns out that banks (with a growing number of encouraging exceptions) haven’t been serving these customers well, including charging more and higher fees for account opening, maintenance and overdrafts. Meanwhile, struggling consumers are turning to alternative providers (as well as to community development credit unions) because they value:

  • Greater transparency (with actual costs clearly displayed like signs in a fast-food restaurant)
  • Better service (including convenient hours, locations and friendly, multilingual staff)

What I really liked is that Servon—an East Coast, Ivy League academic—didn’t just arrive at these conclusions by only reading reports and talking to experts. She actually became a teller at both a payday lender in Oakland, Calif., and a check casher in the South Bronx, N.Y.

Mapping Financial Choices

I also like that several of my Community Development colleagues here at the St. Louis Fed have embraced this community-driven understanding of financial decision-making as well through a “system dynamics” research study, which maps the actual factors that influence the financial choices consumers make.

Like Servon’s work, the forthcoming version of this study will focus less on the narrow “banked/unbanked” framework and more on the broader, CFSI-inspired idea of “financial health.”

Other Areas to Address

Beyond adopting the financial health framework, Servon also suggests rethinking the government/banking relationship and supporting smart regulation so financial innovation or risk taking can thrive with some protections.

Most importantly, in my view, she recommends addressing the macro problems—for example, flat or declining real wages, less full-time and stable employment, and weaker unions—that underlie the demand for the immediate cash that alternative providers offer so well, albeit not so cheaply.

But it’s also true that weak balance sheets—the micro—contribute to the macro problem: Strapped consumers just don’t spend as much. So, we really must address both.

Notes and References

1 “Report on the Economic Well-Being of U.S. Households in 2016.” Board of Governors of the Federal Reserve System, May 19, 2017.

2 Gutman, Aliza; Garon, Thea; Hogarth, Jeanne; and Schneider, Rachel. “Understanding and Improving Consumer Financial Health in America.” Center for Financial Services Innovation, March 24, 2015.

3 “The Precarious State of Family Balance Sheets.” The Pew Charitable Trusts, January 2015.

Author: By Ray Boshara, Senior Adviser and Director, Center for Household Financial Stability