The Asset Price Meltdown and the Wealth of the Middle Class
Edward Wolff, NBER Working Paper, November 2012
Abstract: I find that median wealth plummeted over the years 2007 to 2010, and by 2010 was at its lowest level since 1969. The inequality of net worth, after almost two decades of little movement, was up sharply from 2007 to 2010. Relative indebtedness continued to expand from 2007 to 2010, particularly for the middle class, though the proximate causes were declining net worth and income rather than an increase in absolute indebtedness. In fact, the average debt of the middle class actually fell in real terms by 25 percent. The sharp fall in median wealth and the rise in inequality in the late 2000s are traceable to the high leverage of middle class families in 2007 and the high share of homes in their portfolio. The racial and ethnic disparity in wealth holdings, after remaining more or less stable from 1983 to 2007, widened considerably between 2007 and 2010. Hispanics, in particular, got hammered by the Great Re cession in terms of net worth and net equity in their homes. Households under age 45 also got pummeled by the Great Recession, as their relative and absolute wealth declined sharply from 2007 to 2010.
This raises, as always in my mind, the question of policy: is the problem the boom, or the bust. After all, there's a boom and bust cycle, and good reason to fear it. But should we blame low interests, or the animal spirits?
Suppose I have a house, and you have a house. Each is worth $100,000. Then I value your house at $1,000,000, and loan you $500,000 based on that collateral. You do the same for me.
Now each of us has a house "worth" $1,000,000, plus $500,000 in cash to go buy stuff with. But neither of us can pay back the loan, and we both go bankrupt. The houses, however, are still worth the same old $100,000 each will actually command in a stable market.
If you measure from the peak of the bubble, we lost a lot of wealth. But that wealth was entirely fake, created by a revved up demand for houses as assets expected to appreciate rapidly. (The rule in financial pricing: "anything we all know will happen tomorrow actually happened yesterday").
So...an existential, ontological, and epistemological question: was there a wealth loss? Or did the wealth never "really" exist in the first place? And how would we know?
Edward Wolff, NBER Working Paper, November 2012
Abstract: I find that median wealth plummeted over the years 2007 to 2010, and by 2010 was at its lowest level since 1969. The inequality of net worth, after almost two decades of little movement, was up sharply from 2007 to 2010. Relative indebtedness continued to expand from 2007 to 2010, particularly for the middle class, though the proximate causes were declining net worth and income rather than an increase in absolute indebtedness. In fact, the average debt of the middle class actually fell in real terms by 25 percent. The sharp fall in median wealth and the rise in inequality in the late 2000s are traceable to the high leverage of middle class families in 2007 and the high share of homes in their portfolio. The racial and ethnic disparity in wealth holdings, after remaining more or less stable from 1983 to 2007, widened considerably between 2007 and 2010. Hispanics, in particular, got hammered by the Great Re cession in terms of net worth and net equity in their homes. Households under age 45 also got pummeled by the Great Recession, as their relative and absolute wealth declined sharply from 2007 to 2010.
This raises, as always in my mind, the question of policy: is the problem the boom, or the bust. After all, there's a boom and bust cycle, and good reason to fear it. But should we blame low interests, or the animal spirits?
Suppose I have a house, and you have a house. Each is worth $100,000. Then I value your house at $1,000,000, and loan you $500,000 based on that collateral. You do the same for me.
Now each of us has a house "worth" $1,000,000, plus $500,000 in cash to go buy stuff with. But neither of us can pay back the loan, and we both go bankrupt. The houses, however, are still worth the same old $100,000 each will actually command in a stable market.
If you measure from the peak of the bubble, we lost a lot of wealth. But that wealth was entirely fake, created by a revved up demand for houses as assets expected to appreciate rapidly. (The rule in financial pricing: "anything we all know will happen tomorrow actually happened yesterday").
So...an existential, ontological, and epistemological question: was there a wealth loss? Or did the wealth never "really" exist in the first place? And how would we know?
3 comments:
It goes further than that. I have several old film cameras. Some of them are worth as much or more than they were worth 10 years ago, while others are worth a fraction of the amount.
In general, there is no such thing as absolute wealth. The value of any item depends on what somebody else is willing to pay for it.
In property this shows up in the "rust belt", where the economy has been depressed and declines in house prices have nothing to do with a "bubble" but merely whether people want to live in the area or not.
So what is "real" or "fake" wealth?
Thomas W. correctly notes that the number associated with wealth depends on what people, generally, will offer. Then he asks what is real wealth. I offer two items in answer.
Recently, I stopped by the grocery to pick up some items for easy prep since my wife was planning to be away. I swiped my card at the check out and walked away without considering the number of that wealth or the fact that for most of human history, most people were hungry most of their lives.
It's been few years since my wife got her first "smart phone". As she considered its many apps, I told her "in your hand, you are holding more computing power than existed in the entire world at the time of your birth." She updated facebook.
That's real wealth. Louis Quatorze, he of the solid silver chair, couldn't even imagine.
If you define wealth perhaps a the expectation of funding future needs, then it was a great loss of wealth.
Charlie Munger addresses your question by looking at embezzlement. JKG talked about the expected wealth of a firm that doesn't know it's been embezzled. Then there's the realization they lost what they had. But for Charlie, there's a "functional equivalent of the bezzle", where you lose what you thought you had but didn't really. Regardless the sense of loss and resulting behavior is the same.
So yeah, a real loss.
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