With credit tight and real estate and stocks at multi-year lows, who wins and who loses? Certainly, any trader short the market or long put options is making out like a bandit, while anyone long real estate and stocks is experiencing painful net worth erosion.
However, in the midst of the financial turmoil we're in, how's the "average American" faring? For insight, let's first have a look at household balance sheets.
Household Balance Sheets
According to the Fed's triennial Survey on Consumer Finances (using 2004 data--results of the 2007 survey come out in early 2009), assets owned and debt held by 10% or more of all American families, along with the median dollar value of holdings among the specified percentage of families holding the particular asset or debt, are:
- Checking or other transactional account: 91% of families, $4k
- CDs: 13% of families, $15k
- Savings bonds: 18% of families, $1k
- Stocks: 21% of families, $15k
- Mutual funds and other pooled assets: 15% of families, $40k
- Retirement accounts: 50% of families, $35k
- Life insurance products with cash value: 24% of families, $6k
- Car or other vehicle: 86% of families, $14k
- Primary residence: 69% of families, $160k
- Other residential property: 13% of families, $100k
- Business equity: 12% of families, $100k
- Mortgage on primary residence: 48% of families, $95k
- Car loan or other installment loan: 46% of families, $12k
- Credit card balance: 46% of families, $2k
Clearly (and this should come as no surprise, particularly in light of the mortgage-related crisis we are in), the most significant asset owned by most American families is our primary residences, against which we carry sizable mortgages.
The Poor, the Middle Class and the Rich
The landscape gets more interesting when we probe one layer deeper, to see who owns what and against how much debt. Looking at three distinct groups classified by net worth (again in 2004 dollars), we can list assets and debt commonly held by 40% or more of the households in each group:
The Poor (below 25th percentile): $2k median net worth
- 75% have checking accounts with median value $1k
- 70% own car(s) with median value $6k
- 48% have car loans or other installment loans with median value $11k
- 40% carry credit card balances with median value $2k
Typical leverage: Debt/assets = 0.8 (estimated based on net worth)
The Middle Class (50th to 75th percentile): $171k median net worth
- 98% have checking accounts with median value $6k
- 62% have retirement accounts with median value $34k
- 92% own car(s) with median value $17k
- 93% own their primary residence having median value $159k
- 66% carry a mortgage on their home with median value $97k (60% implied loan-to-value)
- 49% have car loans or other installment loans with median value $13k
- 53% carry credit card balances with median value $3k
Typical leverage: Debt/assets = 0.4 (estimated based on net worth)
The Rich (above 90th percentile): $1.43 million median net worth
- 100% have checking accounts with median value $43k
- 63% own stocks with median value $110k
- 47% own mutual funds with median value $160k
- 83% have retirement accounts with median value $264k
- 44% own cash value life insurance products with median value $20k
- 93% own car(s) with median value $31k
- 97% own their primary residence having median value $450k
- 46% own other residential property with median value $325k
- 41% own business equity with median value $527k
- 58% carry a mortgage on their home with median value $186k (40% implied loan-to-value)
Typical leverage: Debt/assets = 0.1 (estimated based on net worth)
On the asset side of the household balance sheet, the picture that emerges is pretty much as expected - the rich own everything that the poor and middle class do, and have more of everything, item by item. The typical middle class household owns a checking account, car, house and retirement account. By comparison, rich households own what their middle class brethren do, plus a long list of investment assets such as stocks, mutual funds or hedge funds, insurance annuities, second homes or investment real estate, and private businesses. At the other extreme, the majority of poor households have only a checking account and a car.
The situation flips, however, when we look at the liability side of the balance sheet: although the rich have higher absolute dollar amounts of debt, their debt-to-assets ratio is the smallest among the three groups. Borrowing is most prevalent among the middle class, where two-thirds of the households have mortgages on their homes, half have car loans, and half carry balances on their credit cards, resulting in typical household leverage of about 0.4. Among the poor, slightly fewer than half have car loans and about four out of ten households have credit card debt. However, it is actually the poor who are most overburdened by debt, with a high debt-to-assets ratio of about 0.8. This trend of the "asset-poor" being the most "debt-rich" can easily be seen by looking at the fraction of car owners in each group who have car loans and other installment debt: the poor (48%/70% = 0.7), the middle class (49%/92% = 0.5), the rich (27%/93% = 0.3).
Weathering the Financial Storm
Who fares best: the over-leveraged poor, the debt-laden middle class, or the asset-endowed rich?
As real estate and stock prices fall, here's how each group is affected:
- The poor, who do not typically own real estate, stock or mutual funds, are not immediately affected by falling markets. However, a small yet significant subset (12% in 2004, presumably higher today) of these households in the lowest quartile of net worth are homeowners carrying mortgages and, being the most highly leveraged group, are undoubtedly the most adversely impacted by depressed home prices. Further, having little to no savings, this group is the first to fall behind in loan and credit card payments when job losses escalate as the economic downturn runs its course.
- The middle class comprises the bulk of homeowners with substantial mortgages who are feeling the brunt of the fall of the housing market. These households also have retirement accounts with stock and mutual fund positions that shrink as stock prices slide. In the event of a job loss, most of these families can cover their bills for at least a few months by relying on their savings and, if needed, they can also take early withdrawals from their IRAs and 401ks. But, if the downturn lengthens and unemployment rises further, many of these households will unfortunately suffer through home foreclosures and the like.
- The rich experience the fewest financial dislocations, despite the fact that their vast holdings of stocks and real estate are immediately impacted when prices fall, putting downward pressure on the equity in their private businesses as well. Although rich households lose the most money in absolute terms when prices fall, their minimal household leverage (debt-to-assets ratio of just 0.1) makes true financial hardship a foreign concept to most in this group. Because very few of the rich have large mortgages on their homes (and even if they do, they usually have liquid assets they can sell off to reduce leverage), foreclosures among this group will be almost unheard of, however severe the economic downturn becomes.
The recent chain of events is becoming all too familiar: Real estate and stock markets fall, investor sentiment (i.e., among the rich) turns negative; headlines carry news of our ensuing financial crisis, smaller investors (i.e., the middle class) either sell out or hesitate to buy, consumers (all groups) spend less on goods and services and businesses earn less. Then the economy stalls, layoffs begin, sentiment worsens, and market prices fall further, bringing us full cycle--but at a lower level.
If this downward spiral continues, the over-leveraged poor lose their jobs, cars and homes (through foreclosure if they own them or eviction if they are renters). The debt-laden middle class exhaust their savings and deplete their dwindling retirement accounts trying to stave off foreclosure of their homes (but many lose their homes anyway); and the asset-endowed rich watch their asset values plunge but keep their homes and still own America. While an extended economic recession is definitely not desirable for any group, note that:
Economic pain and suffering is inversely proportional to wealth: the poor suffer the most, the middle class are next, and the rich, well, they become a little less rich.
The public policy implication should be clear: at this point, whatever can be done to stabilize the markets should be done. President Bush distributed cash to families last year through his fiscal stimulus package, which helped the consumer and temporarily kept the economy afloat. The Fed, FDIC and the
However, one problem remains - we're not yet on solid ground.
On Tuesday morning,
For any advocates of laissez faire capitalism, this "visible hand" of persistent government intervention in the markets must be appalling, particularly following the apparent successes of American-style capitalism over Cold War communism during the past few decades. However, we are now in a "leveraged asset" crisis and the only way to stop the bleeding is do what it takes to stabilize asset prices, and the only entity capable of acting on a large enough scale to make a difference is the government.
From Economics 101, we know that the four factors of production are innovation, labor, physical resources and money. Despite this financial crisis we're in, America and the world still have plenty of entrepreneurial ideas, people willing and able to work, and all the (arguably diminishing) natural resources we always have had. What is lacking is capital, and at this point, it is only the government that has deep enough pockets to keep the money flowing.
With the U.S. government stepping in so often in recent months and taking ownership (or warrants) in our prime financial institutions, it may be surprising to many that America is involuntarily slipping through some convoluted "looking glass" into a society with increasing government ownership of businesses, where the state, by default, has become the largest market participant.
Such is the irony of modern capitalism, with more government intervention, not less, being needed to keep the ship above water as the economic tide sloshes all around us--poor, middle class and rich alike.