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Growing up without finance

James R. Brown,J. Cookson,Rawley Z. Heimer

Published 2019 in Journal of Financial Economics

ABSTRACT

Early-life exposure to local financial institutions increases household financial inclusion and improves financial health thereafter. We identify the effect of local financial markets using an externally-imposed law that led to sharp differences in credit market development across Native American reservations in the U.S. Individuals growing up on reservations with less financial development enter formal credit markets later and, as a result, have persistently lower credit scores. Although financial health improves after moving from a reservation, it takes longer than a decade before the credit scores of individuals leaving areas with weak local financial markets fully converge with other borrowers. JEL Codes: G21, K40, P48 ∗Brown is at Iowa State University, Department of Finance, College of Business, Ames, IA 50011, USA, [jrbrown@iastate.edu] Cookson is at University of Colorado at Boulder, Leeds School of Business, Campus Box 419, Boulder, CO 80309, USA, [tony.cookson@colorado.edu] Heimer is at Federal Reserve Bank of Cleveland, P.O Box 6387, Cleveland, OH 44101, USA, [rawley.heimer@researchfed.org] This paper benefited greatly from the feedback of participants at several conferences and seminars, including the 2016 Boulder Summer Conference on Consumer Financial Decision Making, the 2016 ITAM Finance Conference, the 2016 Edinburgh Conference on Legal Institutions and Finance, the 2016 Annual Conference of the Society for Institutional and Organizational Economics, University of Florida, University of Georgia, and the Ohio State University. In addition, we appreciate individual comments from Jiafu An, Umit Gurun, and Farzad Saidi. We thank Daniel Kolliner and Timothy Stehulak for outstanding research assistance. The views in this article do not necessarily reflect those of the Federal Reserve Bank of Cleveland or the Board of Governors. Any remaining errors or omissions are the authors’ responsibility. Household finances have important implications for asset price fluctuations, business cycle dynamics, and entrepreneurial activity (e.g., Campbell and Hercowitz, 2009; Mian and Sufi, 2011; Iacoviello and Pavan, 2013; Corradin and Popov, 2015), as well as firstorder effects on consumer welfare (e.g. Melzer, 2011; McDevitt and Sojourner, 2016). Yet, the wide variation in consumer financial health is puzzling. Even when the U.S. unemployment rate was as low as 4.5 percent (2006Q4), as many as 70 million people, or 32 percent of individuals over 18 with a credit score, had a credit history that would have been considered subprime. Because income shocks appear insufficient to explain the variation in credit market outcomes, recent research considers the influence of financial education (e.g., Brown et al. (2016)) or behavioral biases (e.g., Stango and Zinman, 2011; Keys and Wang, 2015) on financial well-being. However, even these individual attributes cannot fully explain the wide variation in credit outcomes across households. In this paper, we examine a potentially important and largely unexplored determinant of household financial health – early-life exposure to financial markets through local financial institutions. Although evidence from other settings suggests that experience with financial markets should have broad effects on household financial well-being (see Malmendier and Nagel, 2011; Anagol, Balasubramaniam, and Ramadorai, 2015), identifying the effect of financial development on household financial health is challenging because exogenous shocks to financial development are rare. Even regulatory changes that affect lending activity are themselves not random, and often coincide with other economic factors that influence the supply and demand for credit.1 Furthermore, it is difficult to construct micro-level measures of financial health that are both geographically precise and comparable across households. We confront these empirical challenges using micro-level consumer credit data from 1For example, the CARD Act of 2009 was enacted precisely because of problems with how individual consumers used credit cards, but nonetheless had sweeping effects on consumer financial health (see Agarwal et al. (2015) or Keys and Wang (2015)).

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