A report from the Federal Reserve Bank of New York indicates that while the household sector is still vulnerable to severe home-price declines, it has recently become less risky.
According to the report, equity in a borrower’s house played a key role in the Great Recession and the weak economic recovery that followed.
Prior to 2006, the Fed said that leverage was low. But household leverage rose rapidly through 2012 as home prices fell and unemployment soared.
Those findings and more were discussed in Tracking and Stress-Testing U.S. Household Leverage released Wednesday.
As conditions were deteriorating, defaults and foreclosures skyrocketed because of borrowers with negative equity..
But as home prices recovered, household leverage fell back toward pre-crisis lows by the beginning of last year.
“‘Stress tests’ predicting future leverage and defaults under scenarios of declining home prices reveal that the household sector is still vulnerable to severe house-price declines, although it has become steadily less risky in recent years,” the report stated.
The report said that tracking household leverage — especially first mortgages, home-equity loans and home-equity lines of credit — is crucial to assessing the risk of re-occurence and guarding against another event.
In addition, the Fed says it is imperative to consider homeowner leverage in scenarios with severe price shocks.