$78 trillion. In the third quarter of 2007 American households controlled $78 trillion in various assets including real estate, equities, pensions, and other forms of wealth. Adding in the liability side of the equation, Americans in the peak year of 2007 had a net worth of $64.2 trillion. A sizeable portion of that net worth […]
$78 trillion. In the third quarter of 2007 American households controlled $78 trillion in various assets including real estate, equities, pensions, and other forms of wealth. Adding in the liability side of the equation, Americans in the peak year of 2007 had a net worth of $64.2 trillion. A sizeable portion of that net worth has evaporated. In fact, that $64.2 trillion is now valued at $50.3 trillion. A 21 percent cut to the American household balance sheet. Now much of this has come because of the housing bubble bursting and the subsequent stock market crash. Even in the Great Depression, household wealth did not evaporate so quickly.
I’ve been digging through research papers trying to find accurate measures of household balance sheets during the Great Depression to try to develop a reference point for our current bubble. The trouble of course is that much of our new toxic instruments like Alt-A mortgages and massive amounts of commercial real estate debt really didn’t have a big impact during the Great Depression. At the time, it is estimated that some 1 million Americans were invested in the stock market. The homeownership rate was rather stable during the early half of the century:
This goes in stark contrast to our bubble peak when homeownership neared 70 percent while the majority of Americans are now involved in the stock market either directly or through a pension fund. Yet looking at research conducted on the American balance sheet during the Great Depression, we find that this current bust has caused more wealth destruction.
This is part XXVII in our Lessons from the Great Depression series:
21. The Big Change
22. The Infection of Consumerism and Living Fake Lives.
23. The Worst Housing Crash in American History.
24. Economic Crises Around the World in Synchronization.
25. Reconstruction Finance Corporation II
26. Pecora Commission Where Art Thou?
It is hard to grasp such a large drop in net worth. Let us chart this out:
*Click for sharper image
The growth in American household assets has been rather unrelenting since the 1950s. We had a hiccup earlier in the decade with the tech bust but we were back on track in a very short time. However, since the peak the asset side of the equation has imploded. We also see on the chart above the increase in liabilities. As in most busts including the Great Depression, assets adjusted quicker than liabilities. While asset prices have come down $13.8 trillion the liability side of the equation has only decreased by $420 billion. How is this disconnect remedied? By massive amounts of defaults and foreclosures since the instrument that caused the bubble was real estate and the debt tied to it.
Now I know that during the Great Depression, the safety net was largely non-existent. There was no FDIC. No Social Security. No large pension funds. So for the most part, people were on their own. It is no surprise then that the unemployment rate peaked at 25 percent with 14 million unemployed Americans.
It is hard to believe that we now have 14.7 million unemployed Americans with another 11.2 million either working part-time for economic reasons or some who have given up looking for work. Yet the pain isn’t as visible as soup lines or men standing outside of manufacturing plants looking for work. Unemployment benefits are done electronically through the internet and in some states, funds are disbursed through debit cards. Yet on a percent basis, Americans have lost more household wealth in this crisis than in the Great Depression. Let us look at the balance sheet from the Great Depression American household:
*Source: Frederic Mishkin - The Journal of Economic History (Dec., 1978)
I struggled to find this data and even the author in the above work had difficulty constructing the data set. Much of this is largely due to the poor record keeping done prior to the Great Depression. As we can see from the above chart, the household net worth peaked in 1929 and didn’t hit a bottom until 1934. From peak to trough, the amount loss was 11 percent. Now why the lag? For the most part, much of the wealth of the American household wasn’t in stocks contrary to popular belief. Of course, the stock market rocked the economy and led to job losses which in turn hurt the balance sheet but many Americans did not have their money linked up in stocks. The lag and hits came with many of the bank failures and subsequent foreclosures. The most visible historical memory is the stock market crash with photos of anxious crowds gathering outside of Wall Street.
It is interesting to note that the patterns of bubbles are rather similar. That is, liabilities keep on increasing even after the peak. Let us look at the liability side of things:
Mortgages were not a gigantic part of the balance sheet. Much of this had to do with mortgages being constructed with a 5 to 10 year term and a balloon payment at the end. Let us take the peak year of 1929 for example. While household net worth (in 1958 dollars - we are focused more on percent changes) was $844 billion mortgage debt was $29.6 billion, or 3.5 percent of net worth. Let us look at our peak data. Net worth peaked at $64.2 trillion and mortgage debt was $10.5 trillion, or 16.3 percent. Now this would make sense since homeownership is much higher than during the Great Depression but it also shows how dependent we were to the housing industry. In fact, that is why the government and Wall Street are so concerned about maintaining high home prices even though in many parts of the country they are still unaffordable. We are approaching the bust in differing ways. Take a look at a paper written in 1933 during the Great Depression addressing various government programs:
It is strange to see a government initiative during the bust seeking affordable housing. How things have changed. Most of the current legislation and programs seek to maintain high home prices (i.e., loan modifications, bailouts, etc). Since much of the American balance sheet is tied to real estate when the housing industry busted, much of the bubble wealth also came crashing down. At the peak real estate made up $24 trillion of the $64 trillion in household net worth. That is a large portion. It’ll be fascinating to look at the Q2 data since housing prices have been coming down but the stock market has rebounded. Real Estate is still a larger segment so I would expect the net worth figure to decrease for the quarter.
What becomes clear is that even though there is more overall prosperity in 2009 than in 1929, there has never been a time in history when so much wealth has been lost. Even the Great Depression did not see such large wealth destruction. We have more humane safety nets in 2009 but these are being strained. Many unemployment insurance benefits are reaching their end even with extended dates. What then for these people? Even though the freefall in unemployment may have stopped, companies are still not hiring. So what then? Trade is still hurting:
The American household balance sheet will only begin to feel some relief when companies begin hiring again. The balance sheet will only be helped when the liabilities side of the equation begins to reflect the real world value of the assets. There are many lessons to learn from the Great Depression. What those in Wall Street forget is that you have to create jobs to have a healthy economy. Without that, this is going to be a long and drawn out recession. Even Ben Bernanke had this to say:
“A lot of things happened, a lot came together, [and] created probably the worst financial crisis, certainly since the Great Depression and possibly even including the Great Depression,” Bernanke said at the start of a town-hall meeting in Kansas City.” - July 26, 2009
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The American Household Balance Sheet. Lessons from the Great Depression Part XXVII: Household Net Worth Drop in Great Depression 11 Percent. Current Net Worth Drop of $13.8 Trillion Equivalent to 21 Percent Drop.
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