Wednesday, August 15, 2018

Inequality and the financial crisis - role of housing and equity prices

The latest research in inequality studies comes from the Minneapolis Fed which draws attention to the evolution of wealth among US households.

Moritz Kuhn, Moritz Schularick, and Ulrike Steins used the Historical Survey of Consumer Finances (HSCF) and examined the distribution of household income and wealth across population groups and asset categories for the 1949-2016 period and found,
Middle-class portfolios are dominated by housing, while rich households predominantly own equity. An important consequence is that the top and the middle of the distribution are affected differentially by changes in equity and house prices. Housing booms lead to substantial wealth gains for leveraged middle-class households and tend to decrease wealth inequality, all else equal. Stock market booms primarily boost the wealth of households at the top of the distribution. This race between the equity market and the housing market shaped wealth dynamics in postwar America and decoupled the income and wealth distribution over extended periods... We estimate that until 2007, middle-class capital gains on residential real estate slowed down wealth concentration in the hands of the top 10% by about two-thirds. The housing bust of 2007-2008 was a watershed event as it hit the middle class particularly hard.
More specifically,
The HSCF data show that incomes of the top 10% more than doubled since 1971, while the incomes of middle-class households (50th to 90th percentile) increased by less than 40%, and those of households in the bottom 50% stagnated in real terms... However, when it comes to wealth, the picture is different. For the bottom 50%, wealth doubled between 1971 and 2007 despite zero income growth. For the middle class (50%-90%) and for the top 10%, wealth grew at approximately the same rate, rising by a factor of 2.5. As a result, wealth-to-income ratios increased most strongly for the bottom 90% of the wealth distribution... Importantly, price effects account for a major part of the wealth gains of the middle class and the lower middle class. We estimate that between 1971 and 2007, the bottom 50% had wealth growth of 97% only because of price effects — essentially a doubling of wealth without any saving. Also, the upper half of the distribution registered wealth gains on an order of magnitude of 60% because of rising asset prices. For the bottom 50%, virtually all wealth growth over the 1971-2007 period came from higher asset prices...
From a political economy perspective, it is conceivable that the strong wealth gains for the middle and lower middle class helped to dispel discontent about stagnant incomes... When house prices collapsed in the 2008 crisis, the same leveraged portfolio position of the middle class brought about substantial wealth losses, while the quick rebound in stock markets boosted wealth at the top. Relative price changes between houses and equities after 2007 have produced the largest spike in wealth inequality in postwar American history. Surging post-crisis wealth inequality might in turn have contributed to the perception of sharply rising inequality in recent years. 
In simple terms, the relative price of the two assets - land and equity - is the driver of wealth distribution and thereby inequality.

For the period from 1971-2007, total wealth growth from houses and stock prices and their respective  shares for different population percentile of the wealth distribution.
But since 2007, following the bursting of the housing bubble and the subsequent equity market boom, there has been a significant shift in trends.
The inequality impact of financial crises is best captured by the graphic below. It shows that the average household in the top 10% of today's wealth distribution is three times as rich as the average household in the top 10% of 1971's distribution, whereas those in the bottom half are poorer. 
Notice the dramatic wealth destruction faced by the bottom half from the financial crisis. And the reason for that being the knock-on effect on housing prices.

Alternatively, one could say that the bottom half were kept in the wealth game for the quarter century till the crisis by the booming housing market. 

Noah Smith has the graph below from the work of Edward Wolff that indicates the shares of total wealth in housing and financial assets in 2013.
The Minneapolis Fed research authors also shine light on the broader racial distribution of wealth and income in the US and associated trends,
The historical data also reveal that no progress has been made in reducing income and wealth inequalities between black and white households over the past 70 years, and that close to half of all American households have less wealth today in real terms than the median household had in 1970... In 1950, the income of the median white household was about twice as high as the income of the median black household. In 2016, black household income is still only half of the income of white households. The racial wealth gap is even wider and is still as large as it was in the 1950s and 1960s. The median black household persistently has less than 15% of the wealth of the median white household... In terms of labor market outcomes, we document that over seven decades, next to no progress has been made in closing the black-white income gap. The racial wealth gap is equally persistent and a stark fact of postwar American history. The typical black household remains poorer than 80% of white households.

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