The Asset Price Meltdown and the Wealth of the Middle Class

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The steep decline in median net worth between 2007 and 2010 was primarily due to the very high negative rate of return on net worth of the middle three wealth quartiles.

Median wealth in the United States declined by 0.7 percent from 2001 to 2004 and median non-home wealth (that is, total wealth minus home equity) fell by a staggering 27 percent during that period. Then, from 2004 to 2007, median wealth grew by 20 percent and median non-home wealth by 18 percent. After the "Great Recession" hit, house prices fell by 24 percent in real terms, stock prices by 26 percent, and median wealth by a staggering 47 percent between 2007 and 2010. The share of households with zero or negative net worth rose from 18.6 to 22.5 percent, and the share with zero or negative non-home wealth rose from 27.4 to 30.9 percent.

In The Asset Price Meltdown and the Wealth of the Middle Class (NBER Working Paper No. 18559), author Edward Wolff examines in detail how the middle class fared financially over the years 2007 to 2010, during a sharp decline in stock and real estate prices. The debt of the middle class had already increased significantly over the previous two decades, and Wolff studies whether the wealth position of these households deteriorated even further over the Great Recession. He investigates trends in wealth inequality from 2007 to 2010, changes in the racial wealth gap and wealth differences by age, and trends in homeownership rates, stock ownership, retirement accounts, and mortgage debt.

Wolff finds that the top wealth (and income) groups saw the percentage increase in their net worth (and non-home wealth and income) rise much faster from 1983 to 2010 than those in the lower end of the distribution. In fact, the average wealth of the poorest 40 percent declined from $6,200 (in 2010 dollars) in 1983 to negative $10,600 in 2010. The greatest gains in wealth and income were enjoyed by the upper 20 percent, particularly the top one percent, of the respective distributions. Between 1983 and 2010, the top one percent received 38 percent of the total growth in net worth.

Among the middle class (defined by the author as the middle three wealth quintiles), the debt-to-income ratio rose from 100 to 157 percent between 2001 and 2007. The debt-to-equity ratio rose from 32 to 61 percent. However, from 2007 to 2010, while the debt-to-equity ratio continued to advance to 71.5 percent, the debt-to-income ratio actually fell to 135 percent. The reason is the substantial retrenchment of average debt among the middle class over these years. Overall debt fell by 25 percent in real terms. The fact that the debt-to-equity ratio rose over these years was a reflection of the 47 percent drop in net worth.

Wolff explains that the key to understanding the plight of the middle class over the Great Recession was their high degree of leverage and the high concentration of assets in their home. The steep decline in median net worth between 2007 and 2010 was primarily due to the very high negative rate of return on net worth of the middle three wealth quintiles. This, in turn, was attributable to the precipitous fall in home prices and the very high degree of leverage of the middle wealth quintiles. High leverage also helps to explain why median wealth fell more than house (and stock) prices over these years and declined much more than median household income.

Wolff finds that the racial disparity in wealth holdings was almost exactly the same in 2007 as in 1983. However, the Great Recession hit African-American households much harder than whites. The losses suffered by black households from 2007 to 2010 are due to the fact that blacks had a higher share of homes in their portfolio than did whites and much higher leverage than whites.

The Great Recession also significantly affected Hispanic households. Their mean net worth was cut in half, as was their mean non-home wealth, their home ownership rate fell by 1.9 percentage points, and their net home equity plummeted by 48 percent. The losses suffered by Hispanic households over these three years are also mainly due to the large share of homes in their wealth portfolio and their high leverage rate. Another likely factor is that a high percentage of Hispanics bought their homes close to the housing cycle peak.

--Lester Picker