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Economic vulnerability and financial fragility

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  • Emmons, William R.
  • Noeth, Bryan J.

Abstract

Unfortunately, many families with the greatest exposure to the economic dislocations of the recent recession also had very risky balance sheets beforehand that were characterized by low levels of liquid assets, high portfolio concentrations in housing, and relatively high balance-sheet leverage. The authors argue that economic vulnerability and risky balance sheets are correlated because they derive from common factors. These factors include a low stock of human capital, inexperience (relative youth), and, in some cases, the legacy of discrimination in housing, education, and employment. Innate cognitive ability interacts with formal education and on-the-job experience to build human capital, while the legacy of discrimination may attenuate the translation of cognitive ability and education into human capital. Acquiring financial knowledge of risk management also requires time and experience and is more valuable to those with high levels of human capital and savings available to invest. Given the combination of these factors, individuals and families who are young, less cognitively able, and/or members of historically disadvantaged minorities are more likely to be economically vulnerable and to hold risky balance sheets because they lack financial knowledge and experience. Moreover, balance sheets of economically vulnerable families before the recent recession were especially risky after a decade of financial liberalization and innovation that increased the access of such families to homeownership and historically high leverage. Economically vulnerable families should avoid “doubling down” with risky balance sheets to enhance their future household financial stability.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2013)
Issue (Month): Sep ()
Pages: 361-388

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Handle: RePEc:fip:fedlrv:y:2013:i:september:p:361-388:n:v.95no.5

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  1. Cory Koedel & Peter Arcidiacono, 2012. "Race and College Success: Evidence from Missouri," Working Papers 1212, Department of Economics, University of Missouri, revised 15 Jul 2013.
  2. Hilary W. Hoynes & Douglas L. Miller & Jessamyn Schaller, 2012. "Who Suffers During Recessions?," NBER Working Papers 17951, National Bureau of Economic Research, Inc.
  3. Richard J. Murnane, 2013. "U.S High School Graduation Rates: Patterns and Explanations," NBER Working Papers 18701, National Bureau of Economic Research, Inc.
  4. William R. Emmons & Bryan J. Noeth, 2012. "Household financial stability: who suffered the most from the crisis?," The Regional Economist, Federal Reserve Bank of St. Louis, issue Jul.
  5. Christopher D. Carroll & Karen E. Dynan & Spencer D. Krane, 2003. "Unemployment Risk and Precautionary Wealth: Evidence from Households' Balance Sheets," The Review of Economics and Statistics, MIT Press, vol. 85(3), pages 586-604, August.
  6. Edward N. Wolff, 2012. "The Asset Price Meltdown and the Wealth of the Middle Class," NBER Working Papers 18559, National Bureau of Economic Research, Inc.
  7. Emmons, William R. & Noeth, Bryan J., 2013. "Why did young families lose so much wealth during the crisis? the role of homeownership," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 1-26.
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