When Markets Fail, Do We All Lose? The Evidence Isn’t As Clear As Reported

There is no doubt that the U.S. economy has not performed well in the last few years or even in the last decade as a whole. As ITIF has pointed out, we lost a larger share of our manufacturing jobs in the last decade than we did in the Great Depression and we rank 43^rd of 44 nations in the rate of progress in innovation-based competitiveness. So, it may not have come as a surprise that a week ago, the Federal Reserve released a report showing how U.S. family wealth and income declined from 2007 to 2010.  However, most mainstream media sources took a single statistic (changes in median wealth) from the over 80 page bulletin and ran away with the wrong message.

When calculating the median wealth (assets minus liabilities), the Survey of Consumer Finances includes perceived unrealized gains as reported by those surveyed. And though there certainly was a decline in real output and consumption during the '07-'10 period, the real changes in family wealth did not dropped nearly as far as those who gleaned onto the change in median wealth purport.  The Fed’s bulletin clearly states that much of the change in wealth comes from declines in unrealized changes in housing wealth (at least 30% of the reported change in median total wealth was due purely to book-losses in housing, according to the bulletin).

As rightly pointed out in the recent release from the Wharton School; declines in housing wealth are quite different from other components of wealth (such as savings accounts) which actually pay for things like, tuition, emergencies, and retirement .  The fact is, for most Americans much of the “loss” of wealth was a reflection of the burst of the housing bubble.   For someone who  bought a house in 1999, they likely saw a big loss in the “value” of their house from 2007 to 2010 but over the 11 year period they likely saw mild gains.

However, the drop in total wealth across the entire economy in fact, is not a drop at all!  In fact from January 1st of '07 to December 31st of '10, GDP actually grew 1.3% (See Figure below). Even when considering changes in GDP per capita, levels in 2010 were above those in 2004.  When considering the implications of standard macroeconomic models such as the overlapping generations model of growth, it is easily understood that there are inter-generational transfers of wealth, and that is exactly what has occurred over the past 6 years. In other words, owners of housing and stocks may have suffered, but new buyers benefited by being able to buy these assets a lower price. These buyers will reap the benefits that the owners suffered, accentuating the fact that there are individual winners and losers. However, real wealth on the whole did not disappear, especially in housing.

Furthermore, what the media by and large completely missed from the report are the significant increases in wealth inequality over the 3 year time period. The very rich (top 10% of the wealth distribution), though they sustained losses too, were able to maintain a much higher percentage of their '07 wealth than the average citizen, for whom homes are generally their single most valuable asset (unrealized value). They key take away is not that we have been "rolled back 20 years," or "watched progress that took almost a generation to accumulate evaporate." Rather, there were on the whole mild losses, but mostly there were individual winners (mostly future buyers) and losers (current owners).

 Graph enlarged: