Cleveland Fed Official Says Education Lifts Income

By Lifestyle and BudgetFOXBusiness

Part 2 of my conversation with Dr. Henry of the Cleveland branch of the Cincinnati Fed. 

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Dr. LaVaughn Henry is proud of the fact that he rose from his inner-city roots to head the Federal Reserve’s regional branch in Cleveland. He is also clear about how he was able to achieve this:  “My parents worked their butts off.  Because my parents emphasized education, I got a doctoral degree from Harvard.”

His undergraduate years were spent at “a small college in Warrensburg, Missouri.”(1)  There he joined “Alpha Alpha, a black fraternity with 10-12 members… none of which had any silver spoon.  But we came from strong families. We believed in ourselves.”  He says from that close-knit group came “one guy who ended up heading a Federal Reserve branch, a Lieutenant Colonel in the U.S. Army, two brigadier generals, the second-highest officer in the Capitol Hill police department, a city detective and a surgeon.”

Henry’s upbringing influences his perspective as an economist. For instance, he will tell you that the economy is improving and that ”consumers are on a more solid financial footing than before the financial crisis.”  And then he tempers this by saying, “We’re talking averages. And averages often mask a lot of variations. When you look at different income groups, you see different outcomes.”

For instance, after decades of being in decline, the national savings rate has increased.   “In the late 1970s the average American was saving 10-to-12% of their disposable personal income, says Henry.  [Then] we went through a marked change in the personal savings rate starting in the mid-1980s.”   That’s when credit cards and home equity loans became more widely available. Instead of driving the same car for years, many Americans began to feel they owed it to themselves to trade up for the latest model every year or so.  And, of course, every family needed at least two.  Modest homes were razed and replaced with McMansions. Every child expected to have a television in their bedroom.  Even kids in elementary school became “label-conscious.”

According to Henry, easy access to credit meant that “people leveraged up even though their income wasn’t going up, so savings rates went down.”  Translation: Money that once would have been socked away for the future was now needed to pay credit card bills, mortgages, car loans, vacations and other amenities. The U.S. savings rate sank to an all-time low of roughly 2% in 2005-2007.  Credit literally allowed us to live beyond our means. At least for a couple of decades.

Then things started to crumble. The first cracks appeared as mortgage delinquencies rose.  An increasing number of debt-burdened Americans were having difficulty making their mortgage payments as their initially low interest rates began to rise. But consumers were not the only ones who had gotten drunk on cheap money.  Financial institutions were also over-extended.  Many had made billions extending loans to individuals who were virtually living paycheck-to-paycheck. Investment banks had bought the loans and re-packaged them as complex “investments” that they then sold to individuals and businesses around the world.  The flaws in this system rapidly became apparent when the entire world was plunged to the global financial crisis of 2008-2009.

Though the impact was brutal in many cases, the recent recession forced lenders to admit their guidelines for extending credit had been too lax. They had been so fixated on making a quick buck they ignored the red flags that suggested many borrowers could ill-afford their loan payments.  Venerable Wall Street institutions such as Lehman Brothers disappeared in bankruptcy.  Investors punished financial stocks.  Shareholders demanded that senior management be fired.

On the consumer side, homes were foreclosed upon. Personal bankruptcies soared. Credit dried up. The silver lining?  Personal balance sheets improved.  As you can see in the two charts below, Americans reduced their reliance on credit and began saving again.

The no-so-good news?   In recent years, consumers have begun taking on more debt.  The flip side to that is the savings rate has plunged. After peaking at 10.5% in 2012, it fell to 5.7% at the end of July, although it remains well above where it was in 2002.   Does this mean we’re setting ourselves up for another economic disaster?   “It’s too soon to determine,” says Henry.

What’s more, it turns out that a relatively small percentage of Americans are responsible for making these statistics look better than they really are.  Politicians like to cite “average” numbers- especially when they want to convince us that the economy is doing better than we think it is. But, as Henry points out, “average” often covers up significant differences.

“With respect to income, everyone took a hit during the recession,” says Henry. However, so far the economic recovery has been uneven.  “For example, about 20% of the population has had solid income growth, while 80% has seen no or negative income growth.”  In addition, “while nearly all income groups have had a decline in the use of debt, this is especially true of those at the top.”  A reduced reliance on debt has also enabled this group to show “very solid growth in savings.”

The problem with this picture is not that some have more than others. That’s built into our capitalistic system.  The real issue is that unless there is a broader dispersion of income gains, “over time, increases in consumption will be [primarily ] coming from those in the top 20%,” explains Henry.  In other words, 100% of our economy will depend on the spending of one-fifth of our population.

Moreover, the reality is that those in the top income group can only consume so much. No matter how much money you have you can only drive one car at a time, even if you own several.  How many second homes can you really use?  At some point people get saturated.  We’re already seeing this.   Instead of consuming, i.e. spending, their income, those in the top quintile are saving it.  In fact, much of the increase in the ”average” personal savings rate is due to sharply higher saving by this group.

“We’re trying to support a growing economy on the income of 20%,” explains Henry.  “This hurts total growth over time. The greater the income equality, the greater the economy will suffer.”

Despite this rather gloomy picture, as I pointed out in last week’s column, [[[[insert link here]]]]] Dr. Henry remains an unapologetic optimist.   “I believe that Americans are innovative enough and free enough to come up with solutions to this. It just takes time.”

“Look at where the jobs were lost in the recession and where they were gained in the expansion. From December 2007 through June 2009 the goods-producing sector lost about 3.6 million jobs. On the service-producing side, we lost about 3.7 million jobs That’s a total of 7.3 million jobs lost.” As the economy has recovered, jobs have come back.  But not necessarily where they used to be. “Through the end of September, we gained back about 8.5 million jobs, but the bulk are on the service side. “So we’re above where we used to be in total jobs, but where the jobs are growing requires a totally different skill set.”

As you might expect based upon Henry’s personal experience, he sees education- the right kind of education- as the key. “Professional and business services have seen the fastest growth.   Leisure and hospitality [also saw gains].(3) …These sectors of the economy require a higher level of education than a high school degree…We need to find effective ways to educate [people] as to where the job needs are- not just throw money at them.”

“I’m not saying ‘throw everyone in college.’  But we have to invest in human capital to help those locked out of the growth.”

“The big differentiator is not race, but education.  Education leads to income growth…A white guy from rural West Virginia or a brother on the south side of Chicago or a Latino in a barrio in West L.A. all have the same issue: lack of education and therefore lack of opportunity.”

  1. Today called “The University of Central Missouri.”
  2. The official start and end of the recent recession.
  3. The healthcare sector is unique. According to Henry, it did not see a decline in jobs during the recession.

What do you think?

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