How the government rebuilt household balance sheets

By Felix Salmon
December 22, 2010
Mark Thoma makes a familiar complaint: that the government's response to what he characterizes as a "balance sheet recession" has done wonders for the balance sheets of banks, but much less for the balance sheets of the population as a whole.

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Mark Thoma makes a familiar complaint: that the government’s response to what he characterizes as a “balance sheet recession” has done wonders for the balance sheets of banks, but much less for the balance sheets of the population as a whole. What the government should have done, he says, is “use fiscal policy to help households make up for losses from the recession”:

For households, the collapse of a housing bubble, which also tends to cause a stock market crash, results in a decline in home equity as well as the loss of retirement and education savings. When combined with the loss of jobs due to the recession, and the fact the debts do not decline with the fall in asset values, the effect on balance sheets can be devastating – much larger than, say, the balance sheet impact of an oil price shock…

Policy has done a good job of preventing even worse problems from developing by rebuilding financial sector balance sheets through the bank bailout and other means.

But household balance sheets have not received as much attention. We could have helped households rebuild their balance sheets, and this would have helped banks by lowering the default rate on loans. Instead, we left households to mostly solve their problems on their own, and then helped banks when households could not repay what they owed.

Mark doesn’t go into any detail on exactly how the government should have done “a better job of helping households”. But it seems to me that, quietly and largely invisibly, it’s actually done exactly that.

Balance sheets have two sides, of course: assets and liabilities. And I suspect that what Mark might have in mind here is attacking the liability side of things, through pushing principal reduction on mortgages or allowing them to be reduced in bankruptcy.

But there’s a problem with trying to reduce liabilities: when the markets lose faith in credit instruments, as we saw during the crisis, the repercussions can reverberate around all markets and all countries. So governments around the world made a conscious decision to keep most bondholders whole, while injecting new capital and diluting equity holders in their attempt to shore up balance sheets.

And that’s pretty much what the government has done with the household sector too. The asset side of a typical household balance sheet is mostly home equity, and there has been a concerted attempt by the government to shore up property values — by reducing mortgage rates to all-time lows, of course, and also by dragooning various public entities (Frannie, FHA, etc) into funding substantially all mortgages being written. Without this public-sector support, banks would write many fewer mortgages at much higher interest rates, and prices would be a lot lower than they are now.

Other household assets have also been boosted by US monetary policy — stocks have been surging, as have bonds, gold, and just about any other financial asset that households might hold. And if the Fed could find a way to accept motherhood and apple pie as worthy collateral at its discount window, it surely would have done so by now.

As a result, household balance sheets are probably healthier now than they would have been if a program of cutting household liabilities, including principal reduction on mortgages, had kept investors nervous about the health of the banking system and of the economy as a whole.

The problem with this strategy, of course, is that debts are still high and real, while asset values can go down as easily as they went up. The financial crisis afforded a once-in-a-generation opportunity for an across-the-board deleveraging of the economy: a move away from treacherous debt and towards equity. We flubbed that chance, and systemic tail risk is much higher now as a result. But so are the markets.


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The greater problem, Felix, is that the majority of households have no assets to speak of. They might own a house, offset by an equally large mortgage, but household economics are in most cases built around the Income Statement rather than the Balance Sheet.

Mortgage modifications would have reduced the interest expense and thus improved the balance on the Income Statement. An appreciating house may look good on paper, but does nothing to make the mortgage payments more affordable.

Of course the key item on the Income Statement is “earnings”. I agree that inflationary stimulus is more likely to lead to job creation than aggressive loan modification, but to this point we haven’t seen enough of it.

Posted by TFF | Report as abusive

The banks have been jacking up their interest rates for unsecured loans, such as credit cards. So, Treasury and the Fed have gone to unprecedented lengths to drop bank borrowing costs to near zero to help them rebuild their balance sheets. Meanwhile they have allowed or even encouraged increasing interest rate charges to the general public which damages the ability of the typical household to rebuild their balance sheets

The US regulators have also done nothing to address the mortgage mess (the banks have screwed up on nearly every possible aspect of that) which could also have allowed more orderly addressing of the housing industry, similar to how re-organization instead of liquidation of businesses in bankruptcy helps.

It is very clear that help for the average person rests on the State AGs and regulators shoulders as the federal government is only concerned about ensuring (and insuring) that the banking industry escapes from this financial crisis unscathed and unaltered. It is not coincidence that the major current legal actions in the financial crisis are led by Cuomo’s recent suit against Ernst & Young and the State AGs probing the mortgage mess.

Posted by ErnieD | Report as abusive

What utter twaddle, Felix!

If the government had let the TBTF banks fail, then simply covered depositors’ losses, the country would be well on its way to recovery by now.

Instead, we’ve got all of the same players sitting in all of the same chairs taking all of the same (or larger) annual bonuses, funded by Treasury and the Fed’s largess (read “taxpayers”).

As others have noted, “most” households don’t hold much (or any) of the financial assets being manipulated higher by Treasury and the Fed.

Households have seen the value of their meagre cash savings eroded by ZIRP and (soon to be evident) QE-fueled inflation.

I often agree with your opinions; however on this one, you’ve blown it completely.

Posted by dbsmith1 | Report as abusive

dbsmith1, firstly most of the banks “bailed out” were not deposit taking companies. Secondly, the ones which were had trillions of dollars of deposits. Are you seriously suggesting in the wake of the CP market freezing that to save the 200bn odd they spent on banks they should have gone for handing over trillions in cash? Where would these people have put their new found cash?

Posted by Danny_Black | Report as abusive

quick search has BofA and C alone with around 900bn a piece in 2008. Chase comes in at around 300bn – seems low to me but not motivated enough to find a wholey accurate figure. Wells is around 750bn. For the record 2.8 trillion is not what the government spent on banks, let alone the cash outlay.

Posted by Danny_Black | Report as abusive

Perspective first: Q. How much have household balance sheets been harmed?
A: Market value down $6 trillion, equity down $7.5 trillion.
The market value of household real estate declined from $22.7 trillion in the fourth quarter of 2006 down to $16.5 trillion in the first quarter of 2009. Owner’s equity in household real estate, over the same period, declined from $13.5 trillion to $6.0 trillion. (See Barry Ritholtz, Big Picture blog, 12/16/10 Owners Equity in Real Estate Down 55.7%.)
You say the government was trying “to shore up property values.” Do you mean re-inflate the bubble? Restore $6 or $7.5 trillion to the market? Do you think that is, or was, sensible policy?
TFF raises a useful analytical question about which population segment of homeowners have “assets to speak of.” Those who lost $7.5 in equity clearly were in different segments than the “majority” who had almost no assets before the crash.
Would Thoma’s recommendation to help the specific segments who suffered the $7.5 trillion loss have a major positive impact on the economy? Does anyone have well framed research and results to answer this? If not, encourage Thoma to do it.
Thoma’s suggestion has a lot of intuitive appeal. Theoretically, the Fed could do it without breaking much of a sweat. If it wanted to. But, who owns the Fed? Who realistically expects the Fed’s owners to even consider such an idea?

Posted by Brizie | Report as abusive


To claim, as you do, that only $200 Bn was spent bailing out the TBTF banks is patently and demonstrably false. The real figure is in the trillions.

For that, we (taxpayers) got (a) a return to the status quo ante for the banks and (b) a continuing depression for the rest of the country.

If the same trillion(s) had been used to clean up the mess, instead of to institutionalize it, the country — real people living normal lives — would be FAR better off.

Posted by dbsmith1 | Report as abusive

dbssmith1, care to give a breakdown on the amount of cash spent on the banks? Not loans that were paid back, cold hard cash because that is what you are advocating giving to depositors.

Posted by Danny_Black | Report as abusive

Hey, according to YOU, it’s “$200 Bn”!

The Fed spent $1.25 Trillion buying MBS in non-market transactions (there was no competitive bid). GS, alone, sold $111,000,000,000. There was no private market for the stuff so, no matter what the Fed paid, it was a bailout to the banks. A give-away.

I haven’t seen a recent estimate of the cost of ZIRP to small savers, but it’s a big number.

I didn’t advocate “giving” money to depositors; I said it would have been better to let the banks fail and simply protect depositors from loss.

But I’d also support writing a big check to every American — $25,000 each (or so). IMO that would have been a far more effective ‘stimulus’ and had an immediate, direct impact on the quality of life of REAL people.

Bailing out corrupt banks with the promise of ‘trickle down’ effects hasn’t worked; all it’s done is establish the precedent that the banks can rape, pillage and plunder with impunity; if they get into trouble, they’ll be bailed out by taxpayers and no bank executive, not one, will ever be held accountable.

Posted by dbsmith1 | Report as abusive

dbsmith, there’s a difference between buying something and giving money away. How has the Fed fared on those MBS transactions? Pretty well, no?

Letting all the banks fail would have been massively more costly.

Christmas at your house must be really exciting. You pass a $1M check to your wife and she gives you a $1M check in exchange. Then you rush to your bank to deposit those checks in the same account they are written against. Your bank manager winks, accepts the transaction, and everybody is happy!

There ain’t no such thing as a free lunch. If everybody gets free money, then everybody pays either by increased debt or through inflation. Do you really believe the government is capable of borrowing $8 trillion on the spot? Or are you advocating for $8 trillion of unsanitized stimulus, “new money” in the economy? That would be massively inflationary and would essentially spell an end to the dollar as a viable currency. (Better learn what a Euro looks like.)

If you are simply asking that the Fed invest in the housing market, supporting prices and keeping interest rates low, then the simplest avenue would be for them to purchase a trillion dollars of MBS. Isn’t that exactly what they did?

Posted by TFF | Report as abusive


Please post the source for your claim that the Fed has ‘done pretty well’ on its MBS purchases.

We’ll never know if ‘letting the banks fail would have been massively more costly’. What we DO know is that bailing out the banks has been a massive benefit to the same few people who caused the crisis.

The Fed is trying everything possible to return to the status quo ante as rapidly as possible. So we can do this all over again in a few years. Great for a few; not so great for the vast majority.

Posted by dbsmith1 | Report as abusive

dbsmith1, ok I know this is a hard concept to understand so I will try and explain this slowly. If I give you 100 dollars that is called “giving you money” and it costs me 100 dollars. If I give 100 dollars and you give me 100 shares that is calling “buying an asset”. Now the cost to me is the difference between what I buy that asset for and the value it has in the market. Note in virtually all cases this is not 100 dollars. Currently to date the Fed has lost exactly zero on these MBS transactions so the cost to the taxpayer is roughly zero – this is modulo some technicalities. Ah but the Fed was taking on a “risk”. Well not really, the credit risk is carried by the GSE who backed the bond – aka US government these days – so the risk is interest rate risk which is roughly zero and prepayment risk which after a couple of year of near zero interest rates has to be pretty low too.

The cost of ZIRP to small savers is roughly zero for each saver. Think what interest rate you were getting in 2007 and apply that to your savings over 2 years. In fact lets get a upper limit. Fed fund rate peaked in 2006 at just under 6%. Lets apply it to those deposits – to get the upper limit, lets assume ALL of them are savings – and we have an absolute upper limit of 370bn USD.

Your brilliant idea costs – remember because it falls into the “giving people money” category – 7.5 trillion USD.

Someone here posted about innumeracy and illiteracy in North Americans – I am guessing you, Nameless and hsvkitty fall squarely into this category.

Posted by Danny_Black | Report as abusive

I choose not to respond to your condescending and insulting post.

People who need to resort to condescenion and name-calling to make a point aren’t worth the trouble.

If you’re happy with the current economic state of the country, good for you.

Posted by dbsmith1 | Report as abusive

PS British people are worse.

Posted by Danny_Black | Report as abusive

dbsmith, I was asking a question…

You made a rather strong assertion, that the Fed *GAVE* $1 trillion to the banks through MBS purchases. That is equivalent to saying that the MBS they acquired are worth nothing. It is up to you to back up that assertion with references.

I’m personally skeptical that the Fed is truly out-of-pocket by that much, but willing to be convinced by the evidence you will surely proffer in response to this SECOND request for supporting details.

Posted by TFF | Report as abusive

“We’ll never know if ‘letting the banks fail would have been massively more costly’.”

Can you offer historical examples where every major bank of a country has failed and the economy has NOT suffered massive job losses? Again, you are making what seems to me to be rather outlandish claims and offering no supporting evidence.

Posted by TFF | Report as abusive

dbsmith1 here is the link to individual buys and sells:  /files/mbs.xls

So far they have sold around 2.3trillionUSD of bonds and presumably bought 3.5trillion, so we have a fair amount of churn. Please show us where they have made a loss as you are claiming that these bonds were worth nothing.

TFF, I’ll give you a hint the amount they lost… it is negative. Just like the TARP to the banks and just like the PDCF to the banks, just like those CDO and MBS tranches they bought at 100 cents on the dollar to “bail out” the banks. Maybe he is confusing the investment banks such as Goldman and Morgan Stanley with GSEs like Fannie and Freddie?

Posted by Danny_Black | Report as abusive

dbsmith1, actually we do know:

Current cost of bailing out the banks is negative. Cost of your brilliant idea to bailout depositors is over 2 trillion. Your even more brilliant idea to give 25,000USD to every american would be 7.5trillion. You were insulted when I called you innumerate so I won’t point out 7.5 trillion > 2 trillion > 0.

PS letting the banks fail and making the depositors whole is the same as giving them the cash they have in their deposits given that they are at the bottom of the creditor pile with just common equity holders below them. But of course you already knew that right?

Posted by Danny_Black | Report as abusive

Actually, maybe this is an job for an intrepid financial reporter/financial analyst…. work out exactly what the P&L is for the various fed programs. I know it is alot more work than just quoting the face value or adding up all the overnight loans and pretending they are one big loan but surely thats what intrepid financial reporters are meant to do, no?

Posted by Danny_Black | Report as abusive

1) One of the stated virtues of inflation, indeed, is that it reduces the real value of the liabilities.
2) One of the reasons I shrug off complaints that certain forms of stimulus are less likely to be spent is that, really, improving balance sheets doesn’t strike me as “wasted” money in the current environment. Stimulus should be evaluated mostly on other terms than how likely it is to be spent.

Posted by dWj | Report as abusive

Actually, a correction… misread the spreadsheet. The fed split out their swaps into separate buys and sells.

Posted by Danny_Black | Report as abusive

Danny black said:

“I know it is alot more work than just quoting the face value or adding up all the overnight loans and pretending they are one big loan but surely thats what intrepid financial reporters are meant to do, no?

Danny, no one but YOU said they were one big loan. We all, in spite of your insults, can read and divide.

Being you are from the UK and yet defend Goldman as though you worked for them…. let me guess…you did?

Posted by hsvkitty | Report as abusive

This is a very interesting discussion I must say. Being that I am very new to the financial sector could somebody please explain to me what the following stands for TBTF, TARP, PDCF ????

Posted by Francis_A | Report as abusive

TBTF = “too big too fail”. During the crisis stage in 2008, first Bear Stearns and then Lehman were allowed to fail. After that, the Fed stepped in with some pretty dramatic actions to save AIG, C, and others from going under. The belief was that those companies were too large, and too strongly interconnected with the rest, to be allowed to fail — the failure of even one would bring down the whole deck of cards.

TARP = “Troubled Asset Relief Program”. I think the idea at first was to relieve the banks of some of their “toxic assets”, protecting their balance sheet from further losses. That idea stalled because nobody was able to figure out a sensible price at which to trade the assets (or perhaps because it was politically unpalatable to do so). Thus the major component of TARP was the distribution of a few hundred billion dollars of cash to the banks (who issued preferred stock in return). TARP was generally framed as loans and has mostly been repaid. In some cases those loans were converted to equity — which is being sold at a modest profit. Too early to close the book on TARP yet, but it seems certain that the Treasury’s loss on TARP will be very small in comparison to the trillions of dollars in fiscal stimulus that is being handed out to middle-class households across America. TARP was basically a band-aid, with the REAL bailout being the various tax cuts and spending programs, and the aggressively low interest rates that the Fed is maintaining.

PDCF = “Primary Dealer Credit Facility”. Overnight loans from the Fed to the banks, for the purpose of keeping liquidity high and keeping short-term interest rates low. I’m less familiar with the details of that, since this is the kind of stuff that the Fed does REGULARLY, but of course there have been no direct losses on this program.

Posted by TFF | Report as abusive

hsvkitty, may want to go back and read what the reporters were saying including the original article.

Posted by Danny_Black | Report as abusive

I know the english language isn’t your strong point.

Posted by Danny_Black | Report as abusive

TFF, one minor but important point about the PDCF is that the loans were collateralised.

Posted by Danny_Black | Report as abusive

Yes, the PDCF loans were collateralised.

How was that different from what the Fed has always done? Are the usual overnight loans NOT collateralised? Or did PDCF extend them to more institutions?

Posted by TFF | Report as abusive

From the feds site:

“How is this different from discount window lending to depository institutions?
This differs from discount window lending to ***depository*** institutions in a number of ways. Currently, the primary credit facility offers overnight as well as term funding for up to 90 calendar days at the primary credit rate secured by discount window collateral to eligible ***depository**** institutions. The PDCF, by contrast, is an overnight facility that will be available to primary dealers (rather than depository institutions).” At the time virtually all of the investment banks were not depository institutions – important exceptions being Citi and JPMC.

Also the collateral for the discount window is much much much more restrictive.

Posted by Danny_Black | Report as abusive

Okay, so the discount window is only available to depository institutions. The PDCF, in contrast, sounds a little like the overnight funding market (commercial paper?) that got Lehman in trouble when it dried up?

I greatly appreciate your efforts to educate, and apologize for being slow.

Posted by TFF | Report as abusive

The CP market almost completely dried up when the Reserve Fund broke the buck after LEH died. The Asset backed commercial paper market was under stress since 2007. The innovation in the PDCF was the type of collateral accepted and that it was available to primary dealers.

By the way the CP market drying up is something that seems to get very little coverage as to how close the US was to the brink. If that had failed then US companies would be running a cash-in cash-out business. No invoice financing, no terms and conditions for payments, no salaries unless the cash was to hand. For all the fuss people are making that is what Paulson, Geithner and Bernanke brought the US back from under extreme pressure in Sept and Oct 2008.

PS no apology needed all here to learn…

Posted by Danny_Black | Report as abusive