Our Net Worth Is Down 39%. How Worried Should We Be?

It’s unlikely that most families will be able to make up for lost time after a 21-year period in which growth in their net worth has averaged out to less than nothing. However, some analysts are clinging to misconceptions that families' wealth decline was a fluke.

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It was hard not to be shocked by last week’s Federal Reserve report showing that the typical American family’s net worth fell 39% between 2007 and 2010. Similarly, figures released by the U.S. Census Bureau on Monday showed a 35% decline in net worth between 2005 and 2010. For people between the ages of 35 and 44, the drop was a staggering 59%, although the dollar amounts were smaller.

Of course, you’d expect people to be worse off because of the recession, but the sheer size of the loss was so great that commentators immediately started trying to explain it away. Most of them blamed the largest part of the decline on the bursting of the housing bubble: First, home prices soared, reaching a peak in 2006. Then when the boom ended, prices plummeted. By this reckoning, losses from the housing bust weren’t real losses — they were simply the result of giving back capital gains that had existed only on paper.

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There’s some truth to that explanation. While home equity accounts for well over half the net worth of many American families, it doesn’t necessarily affect people’s day-to-day finances. But it would be a mistake to dismiss deteriorating net worth figures as nothing more than a statistical fluke that has little impact on the real standard of living. The data in the Fed report point to deeper, long-term problems in the U.S. economy. To see what they are, it helps to correct three misconceptions about the recent sharp decline in household net worth:

Misconception #1: The drop was nothing but a correction caused by the housing bubble. The major assets owned by middle-class Americans include tax-deferred retirement accounts and mutual funds, as well as home equity. And while it’s true that those are long-term investments and could all have just been suffering paper losses, this explanation crucially ignores the time frame.

The market value of houses may vary from summer to winter, and one month’s gains for the Dow may be followed by an equal loss the next month. Such short-term ups and downs don’t affect the long-term growth in a family’s wealth. But for middle-class Americans, losses have fully offset the gains for more than two decades. The Fed surveys the finances of American families every three years, and the most recent report calculates that the net worth of the typical (median) household stood at $126,400 in 2007 and sank to $77,300 in 2010. But a Bloomberg Businessweek analysis of Fed data concluded that the real net worth of a typical family in 1989 was 3% greater ($79,600 after adjustment for inflation) than it was in 2010. That means there was a 21-year stretch – or half a working life – during which the typical family’s growth in net worth averaged out to less than nothing. There’s no way most people will ever be able to make up financially for so much lost time.

Misconception #2: The real problem was the severity and length of the recession. An alternative explanation for the magnitude of the recent decline in net worth is to blame it on government policies that allowed the recession to become much deeper than it should have been and then failed to sustain a quick recovery. Had prices not continued to fall as low as they did by 2010, this thinking goes, the decline in net worth would have been a lot smaller – and a significant chunk of the paper losses would have been erased by a strong rebound.

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It’s true that the recent recession was unusually deep, and perhaps it could have been better managed. But that doesn’t explain why the typical family’s net worth has been set back to the levels of 1989. Not coincidentally, that’s around the time policymakers began worrying about the need to reform programs such as Social Security and Medicare to take account of all the members of the Baby Boom generation who were approaching retirement. Instead of acting preemptively to address that issue, which began to cast a pall over U.S. economic growth, every sort of stimulus was tried – Fed Chairman Greenspan’s expansive monetary policy, President George W. Bush’s tax cuts, Fed Chairman Bernanke’s quantitative easing and President Obama’s stimulus program. Each of these gave the economy a short-term boost, but none of them could restore America’s historical prowess as a wealth-creation machine.

Misconception #3: Stagnation is a manifestation of growing economic inequality. High economic inequality may be a bad thing, but the real problem is what has happened to the vast majority of people in the middle of the income scale. Between 2007 and 2010, median incomes declined by 5% to 9% for more than three-quarters of U.S. households. The lowest fifth of the population actually rose slightly, possibly because of a growing number of retirees living on modest but stable Social Security benefits. Net worth fell for all but the top 10%, where it remained stable. The biggest percentage decline in net worth – more than 40% – was among households earning $57,800 to $94,600. Indeed, most Americans who would consider themselves middle class were big losers. The important question is why those people haven’t been able to accumulate wealth, on balance, and whether any recovery is in sight.

Since 2010, the net worth of American families has recovered somewhat, but is still well below its pre-recession high. The national home-price index is almost 5% lower than it was two years ago. The stock market is up, but by less than 10%. As a result, many families are only marginally better off today than they were when the Fed report concluded in 2010. And they are unlikely to be able to rebuild their savings, since after adjustment for inflation, median household income has declined over the past two years.

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What all this illustrates is that there has been a breakdown in America’s net-worth accumulation that goes back quite a long time. To fix it, the Federal budget may need to be brought into better balance, but structural reforms are even more important. In addition to rebuilding infrastructure and improving education, there also has to be a redesign of Social Security, Medicare and other entitlement programs to put them on a sound financial footing, given the challenges of an aging population.

Postponing such reforms might be tolerable if the global economic outlook were more positive. But the growing likelihood of a recession in Europe could push the U.S. economy from stagnation back into recession. The Fed report also showed that American families are saving less for long-term goals, such as buying a home, paying for college or retirement, and more for immediate purchases and to have cash on hand. That’s a sign that they have shifted to a defensive financial position because they foresee more tough times ahead – and they’re probably right.

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