Government Intervention and the Irony of Modern Capitalism

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:

Financial assets:

• 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

Nonfinancial assets:

• 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

Debt:

• 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

Assets:

• 75% have checking accounts with median value $1k
• 70% own car(s) with median value $6k

Debt:

• 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

Assets:

• 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

Debt:

• 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

Assets:

• 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

Debt:

• 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.

Policy Implication

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 U.S. government’s recent moves have all helped.  These include rescuing Bear Stearns and AIG; saving Fannie Mae (FNM) and Freddie Mac (FRE); coordinating orderly takeovers of WaMu (WM) and Wachovia (WB); increasing deposit insurance levels from $100k to $250k, preparing to buy $700 billion of "toxic" mortgage-related assets from the banks, and buying commercial paper in the markets on Tuesday.

However, one problem remains - we're not yet on solid ground.

On Tuesday morning, Australia cut rates by 100 basis points, which is twice as much as was anticipated. Pimco's Bill Gross is right to push the Fed for a similar massive rate cut later this month. A coordinated global rate cut is also in order.

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.

 

Comments

[kowalski:]

Hahaha... These statistics are a complete joke.

So 93% of the rich own cars with median value $31k ?!

I assume it must be aliens from another planet who own all the Ferrari, Porsche, Mercedes Benz, Bentley, Rolls-Royce, Aston Martin, Lamborghini, Maybach etc.

2008 Oct 08 08:02 AM

[naterey:]

Median, Kowalski, not mean.

2008 Oct 08 08:24 AM

[Chris B:]

What I would like to hear is a guarantee that the government will someday re-privatize the broken up parts of Freddie, Fannie, AIG, and the various mortgage backed securities they have bought. If things stabilize and these government investments increase in value, selling them might be our only chance to tackle the national debt and the entitlements problem. If they are never sold, then conservative socialism will have occurred.

2008 Oct 08 09:40 AM

[BARAKA:]

How about government releasing some $$ to buying Great companies Cheap before foreign monies take these jewels away? It will also inject the much needed confidence. No more foolish deregulations and induced leverage and punish those that took everybody to the cleaners.

2008 Oct 08 10:47 AM

[carey_jim:]

It isn't helpful to call:

The top 10% of Americans rich
The bottom 25% of Americans poor
The second quartile (50-75%) middle class.

It's more compicated than that.

For example, it's well-known that:

The top 1% own about 33% of the wealth in America
The bottom 80% own about 15% of the wealth

Take a look at this well-respected website to get a feel for wealth and income distribution in the United States:

sociology.ucsc.edu/who...

2008 Oct 08 12:06 PM

[CLH:]

Few businesses will be taken over by the gov. They know they are incapable of running anything--including our schools.

2008 Oct 08 01:37 PM

[JasonC:]

On intervention, it only conflicts with the dreamy abstractions between the ears of ideologues. Out in the corporeal world, government and central bank intervention in financial crisis is as old as capitalism, easily 300 years. There isn't anything new about it.

On the accounting silliness, it ignores the earned incomes of all involved and is therefore an exercise in futility. The young have little cash and a car, but they have jobs and long futures earning. The old have houses and business and retirement accounts - and often are already retired, or will be soon. No accounting that ignores the *income statement* is meaningful, and least of all when most of the wealth involved isn't in the form of capital anyway, but of labor power.

2008 Oct 08 01:51 PM

[Umm, yeah:]

Thank you for that link, carey_jim!

2008 Oct 08 03:59 PM

[notsosmart:]

a house or car are not assets.you need a roof over your head & in most cases a car or two to maintain your life. an asset is something that gives you a profit. a car & house cost you-liability.many people were fooled by the folks who were interested in collecting interest from these suckers.my house is paid,my cars are paid & my cards are paid in full every month.i never took a heloc.now im supposed to feel sorry for these folks who thought the roof over their head was a atm machine.maybe they can find a tent with a granite counter to live in.

2008 Oct 08 05:30 PM

[Moon Kil Woong:]

Hmmm, when people start smashing the glass of the banks and brokers we'll know class warfare is about to begin. In the past rich people engaged in philanthropy as a type of revolution insurance. It appears they haven't been paying their premiums. Obama can force some payment by the richest by raising their taxes to lower them for the middle class. I wonder if that will be enough to prevent Le Revolution.

2008 Oct 08 11:01 PM

[trader58:]

constructe, your'e comment is scary but true.

2008 Oct 09 02:04 AM

[vodka_tonic:]

the title has very little to do with the frigging article !!!

2008 Oct 09 03:30 AM

[PeteK:]

"notsosmart" : You are really smart. If most people do the same like you, this whole country will be at peace and harmony. But too bad in this country, too many people keep thinking that the Government owes them something and blame anything except themselves for their failures.

2008 Oct 09 04:30 AM

[johnbee:]

Well said - but the cause of this crash was US bankers lending good money from savers to bad risks to maximise sham profits from which huge salary commissions were paid. To keep the scam at bay they bundled bad loans with good to get AAA ratings. These were then securitised and sold on (or laid off) to banks all around the world who were either suckered or tunrned a blind eye to it as they made big profits also.This is pure fraud -not negligence- nor is it public greed- who had cheap loans thrown at them-. Bankers should know better and the high flyers need be jailed and stripped of their fraudulent gains to preserve the good name of capitalism or we will get socialism and lose democracy. This is the true moral of the tale.

2008 Oct 09 11:39 AM

[bbzz24:]

your stats are quite dubious. for example average credit card debt per family (all families): $9,300

www.creditcards.com/cr...

Credit card balance: 46% of families, $2k

i hope you are not suggesting that 54% of families pay in full every month their 9,300 and the other 46% you are talking about pay at month end 7,300, this is quite off the average annual income of 46,000 per household.

2008 Oct 09 03:48 PM

[Ray Lopez:]

www.taxfoundation.org/...

Is another link, less biased and politican than Jim's link, and it shows the top 1% have at least $388k in income a year, which sounds about right from what I've seen in the U.S.

2008 Oct 09 06:00 PM

[taxed2much:]

it makes me want to go to washington DC and just find a group of our elected officials and begin uncontrolably vomiting and spewing monumentous amounts of chunk all over them. I would hope this impossible feat would I be able to maintain for at least 10 whole minutes. Chasing them and spewing ridiculous amounts of bile and spunge clods upon their heads and persons completely and thoroughly soaking all who have ever written in an earmark or subsidy or a handout to a lobbying group all the way through clothing to the skin with puke. I think that might make alot of us feel better and would get the message across that we as a Nation are fed up with how our lives are being ruined by their innane repetitous inept (but carefully planned to benefit them) policies that do not help anyone in this country without it benefitting themself. Yes they make me sick. They should do the same to you and I hope I see you there vomiting your spew chunks of bile upon another many shamefull disrespecting politicians. Do it at the local and state level too cause those idiots have been copying Main St. all along. Puke Puke and puke some more.

Barf for change. Barf for change. Barf for change. Barf for change.
?:^O>bbbbweawoowwew... woewaowaofofoeiossssssdsspsppslstsplatsplatptooey. ?:^O>
Barf for change. Barf for change. Barf for change. Barf for change.

2008 Oct 10 02:54 AM

[the gor:]

i agree with not so smart except on the point that the home not being an asset. In 2005 before this whole mess came to issue we had a brand new home built. we needed a 4 bedroom because both of my elderly parent were not able to live by themselves anymore and we needed the extra room. When built this house which is 1900 sq feet 4 bedroom 2 bath on a .64 acre lot cost us 125000 to build (this included the land). We put down 24000 cash from savings and auction items I sold at Swan Galleries. WE had to get an ARM to start and the house appraised at $140000 before it was even built. 1 year later we refinanced to a fix rate mortgage at 6.0%. The home was then appraised at $200000. we kept under the 80% cutoff for having PM Insurance got cash back paid off all out debt and pay less now then we did when we had an ARM. Now I do not claim to be an economics major...god who could be these days, but how is the home not an asset?

2008 Oct 29 11:20 PM