Discussion of Household Borrowing High and Lending Low Under No-

ArbitrageJonathan Zinman

Karyen Chu *Federal Deposit Insurance Corporation

FDIC CFR Workshop 2006

* The opinions expressed in this presentation are mine alone and do not necessarily reflect the views of the FDIC

What Is This Paper About?

Paper examines the observed behavior of some US households that pay high interest rates on credit card balances while maintaining lower-yielding balances in bank accounts Borrow High Lend Low

Average US household with a credit card pays roughly $100 per year in finance charges to hold bank account balances instead of using them to pay down credit card debt

What Are Some Contributions Of This Paper? Focus on the cost of BHLL (LL = demand deposit balances)

Previous papers that have examined BHLL have focused on the size of the stock of liquid assets available Bertaut and Haliassos (2002) Gross and Souleles (2002)

Asks whether observed BHLL behavior is consistent with neoclassical models of consumer behavior

What Data and Methods are Used? Uses the 2004 Survey of Consumer Finances to

calculate:

Focus on demand deposit balances in calculating the wedge Checking and savings deposits Adding money market and call accounts did not materially

impact results

},min{__ DDbalCCdebtwedgeBHLLUnadjusted

)]}(*[,0max{_ at

cii rrUnadjWedgeCostUnadjusted

What are the Paper’s Findings?

Most households incur very small monthly BHLL costs

Upper bound (all 2004 SCF HHs w/ CCs):

mean = $15.38; median = $0;

75th percentile = $13.97; 90th percentile = $40.50

Adjusted for recurring expenses (all 2004 SCF HHs w/ CCs): mean = $13.62; median = $0;

75th percentile = $10.20; 90th percentile = $36.13

Adjusted for precautionary savings (all SCF HHs w/ CCs):

mean = $6.19; median = $0;

75th percentile = $0; 90th percentile = $13.90

What are the Paper’s Findings? (cont’d) For households with no credit card debt, the cost of

holding demand deposits rather than higher yielding assets is similar in magnitude to the BHLL cost:

Upper bound (CC borrowers):

mean = $27.38; median = $11.14; 75th percentile = $30.42; 90th percentile = $68.15

Upper bound (Non-borrowers):

mean = $30.87; median = $9.00; 75th percentile = $26.38; 90th percentile = $68.75

What are the Paper’s Findings? (cont’d) Observed BHLL behavior is consistent with neoclassical

models of consumer choice Implicit value of liquidity

Finds no support for hypothesis that lower net worth households disproportionately incur substantial BHLL costs

Some Questions, Thoughts and Comments Table 3 (adjustments for implicit value of liquid assets)

Only shows results for the entire sample of 3,476 HHs with a credit card

Would be helpful to also report results separately for credit card borrowers

Upper bound (all 2004 SCF HHs w/ CCs) from table 1:

mean = $15.38; median = $0; 75th percentile = $13.97; 90th percentile = $40.50

Upper bound (2004 SCF HHs who are CC borrowers) from table 1:

mean = $27.38; median = $11.14; 75th percentile = $30.42; 90th percentile = $68.15

Some Questions, Thoughts and Comments (cont’d) For households with no credit card debt, the cost of

holding demand deposits rather than higher yielding assets is similar in magnitude to the BHLL cost

What are the estimated costs from other studies that have tried to quantify the opportunity cost of holding more liquid but lower-yielding assets?

Are their estimated costs comparable to the costs reported in table 1, column 4?

Some Questions, Thoughts and Comments (cont’d) Does the SCF give an accurate picture of a household’s

average credit card balance or average demand deposit balance?

Balances are a snapshot of a point in time

Do credit card balances or demand deposit balances vary a lot from month to month for many consumers?

Some Questions, Thoughts and Comments (cont’d) Paper only looks at the costs of simultaneously holding

demand deposits and carrying credit card balances

Argument of precautionary savings, high liquidity is highly persuasive for why consumers would choose to hold positive demand deposits even with positive credit card balances

What about other, less liquid, assets that could still be drawn upon to pay down a credit card balance