Stress testing household debt

Neil Bhutta; Jesse Bricker; Lisa Dettling

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We estimate a county-level model of household delinquency and use it to conduct “stress tests” of household debt under various economic scenarios, including CCAR scenarios for unemployment and house prices.

Our estimated model indicates that delinquency rates respond more strongly to changes in house prices and unemployment when debt-to-income ratios are higher and when more debt is held by lower credit score borrowers, and also when house price shocks are coupled with unemployment shocks (consistent with the “double-trigger” view of mortgage default).

Although by 2017 Q4 household debt had climbed above the levels observed just before the financial crisis, our analysis suggests that the 2017 Q4 stock of debt is somewhat less vulnerable to shocks than just before the crisis.

We trace the decline in expected delinquency rates under stress to an improvement in debt-to-income ratios and an increase in the share of debt held by borrowers with relatively high credit scores.

Abstract

We estimate a county-level model of household delinquency and use it to conduct “stress tests” of household debt. Applying house price and unemployment rate shocks from Comprehensive Capital Analysis Review stress tests, we find that forecasted delinquency rates for the 2017 Q4 stock of debt are moderately lower than for the stock of debt before the 2007–9 financial crisis, given the same set of shocks. We trace the decline in expected delinquency rates under stress to an improvement in debt-to-income ratios and an increase in the share of debt held by borrowers with relatively high credit scores. We also consider several alternative scenarios, including one where the size of house price shocks depends on current housing valuations. Under this scenario, we forecast a much lower delinquency rate than occurred during the crisis, as housing valuation measures were much more benign in 2017 than they were precrisis.

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