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May 7, 2020

Why the Wealth Gap Widens During Recessions

Discussions of recessions and market downturns are often littered with emotional agendas, subjective opinions and fear-mongering. And it is not difficult to see why. 

With most people in the US less than a paycheck away from poverty, recessions are a threat to the average American’s precarious financial security.

Timothy Smeeding, professor of economics and former director of the Institute for Research on Poverty, wrote that “during the Great Recession, the wealthiest Americans lost the most wealth in absolute terms, whereas the middle classes lost the most in proportional terms. This pattern arises mainly because middle class losses in the housing market have been substantial.”  

The last major recession in 2008 hit US working- and middle-class families disproportionately hard. Five years later, by 2013, the unemployment rate was still as high as 8% and single-family mortgage delinquency hovered above 10%. Meanwhile, the stock market, in which the wealthy owns the most, fully recovered from the crisis in 2013. In the ten years since the crisis, the stock market has witnessed a 316% return from its lowest point in 2008.

This clearly delineates that the wealth gap widens during downturns, most recently during the Great Recession of 2008. The richest got richer and ‘middle class’ Americans were thrust closer to poverty than ever before.

Why would this be the case?

Education and Job Availability

By definition, recessions involve decreased demand for goods and services, leading to factory closures, mass layoffs and falling wages. There is a push for innovative technologies that can cut down on the number of people needed. While this props up engineering, business and tech jobs, it is done so at the expense of the front-line workers.

Since the Great Recession ended in 2009, the job market has changed drastically such that jobs requiring college-educated workers have seen the biggest increase and enjoyed pay gains.

Non-college grads, by contrast, have faced dwindling job opportunities and an overall 3% decline in income.

The markets seeing rapid growth, and in turn providing employment opportunities, are related to technology, services and digital products. Using the S&P 500 composition as a proxy for market demand, the information technology sector saw an increase of 3% from 2001, whereas industrials saw a decrease.

Why are we seeing fewer opportunities for the high-school grad workforce? The answer lies in the shifting economy of the US. Jobs in manufacturing, possibly the biggest employer of non-college graduated employees, are 1.5 million less than when the recession began in 2007. Construction or factory work was a lifeline for those with a high-school education. The workers were usually unionized and could ask for better pay and benefits. The sad fact is that the demand for such jobs has dropped significantly. 

Along with demand, pay for jobs not requiring a college degree has decreased on the whole. According to EPI (Economic Policy Institute), college graduates, on average, earned 56% more than high school grads in 2015. That was up from 51% in 1999 and is the largest such gap in EPI’s figures dating to 1973.

Home ownership

Home ownership is another measure of wealth that shows how the wealth gap grows during recessions. 

Household wealth — the value of homes, stock portfolios and bank accounts, minus mortgage and credit card debt and other loans — jumped 80% in the past decade. However, data from the Fed shows that more than one-third of that gain — $16.2 trillion in absolute dollar amount — went to the wealthiest 1%. Just 25% of it went to middle-to-upper-middle class households. The bottom half of the population gained less than 2%. 

To add to that disparity, nearly 8 million people lost their homes during the recession and shortly after. The homeownership rate fell to about 60% in 2016 from roughly 70% in 2004 for middle-class Americans. There are little to no chances of recovery, since the sharp price increases since then have made it impossible for potential new home owners to afford a livable home.

There is also a racial element to this divide. Homeownership is heavily skewed towards white families. In 2016, 72%of white families owned their home, compared to just 44% of black families. Between 1983 and 2016, Latino homeownership increased by a dramatic nearly 40%, but it remains far below the rate for white homeowners, at just 45%. 

The racial wealth gap has only widened in the past decade. The median household wealth of white, black, and Hispanic households all dropped around 25% after the burst of the housing bubble. But white households recovered at a much faster pace. By 2016, black households had lost about 30% of their wealth, compared to 14% for white families.

Types of investment assets 

While the divergence between the financial picture of the wealthiest Americans and middle-class Americans was laid bare in the Great Recession and its aftermath, the foundation for the divide was laid years before. 

Wealthier Americans have access to a lot more investment options than the average person. A majority of their wealth comes from investments that are riskier and offer a higher rate of return.

An analysis of the Federal Reserve’s Distributional Financial Accounts data shows that the top 1% of wealthy families own more than half the national investment in stocks and mutual funds. When the stock market recovered in 2011 after a tumultuous 3 years, net worth not held in real estate actually increased by more than $80,000 for the top 5% of the population. The same was not the case at the 75th percentile, the median, or at the bottom of the distribution.

Market participation rates for middle-income Americans were lower in 2016 than 2007.

Part of the reason is that more and more people are having to take on contract, freelance, or gig work to replace or supplement their income. These types of employment rarely offer retirement savings options.

Even if jobs offer retirement savings and pension matches, most middle-class college educated young  adults are too steeped in student loan debt to even think about saving for retirement. The monthly payments for student debt and consumer debt alone make it impossible to have enough of a cash flow to invest in the market. 

Looking outside the stock market, most of the wealth of 90% of Americans comes from their homes. When the housing market crashed in the recession of 2008, it unjustly impacted the middle class. The same people that got impacted by the real estate crash also hold more than three-quarters of the national household debt.

Conclusion

The housing bubble burst coupled with the job market decline led to a widening economic gap that never tapered off even during one of the best economic recoveries in living history.

In many ways, the growth in the wealth gap is a symptom of the recession, not the cause. The wealthy invest in a college education and networking opportunities in careers that have good wage increase and growth potential. Additionally, they have the time and liquidity to invest in asset types that provide a higher rate of return, while utilizing tax advantaged accounts. They own homes that appreciate in value and invest in real estate that pays off.

Wealth inequality is a function of factors such as education, career opportunities, investments, debt, and more. As we’ve seen from past recessions, the gap can be exacerbated by the same forces that caused it in the first place. The only real and long term solution is to build rising incomes, smarter saving, and more education on finance into the average person’s financial toolkit.

 

 

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