I'm about to share a statistic that you should remember every time you think about the Great Recession, and why the recovery has been so painstaking. It's going to illustrate precisely how devastating the downturn was for your typical American family and the size of the hole we've been trying to dig ourselves out of.
Ready? Here goes: Between 2007 and 2010, the median net worth of U.S. households fell by 47 percent, reaching its lowest level in more than forty years, adjusted for inflation. In other words, middle class wealth virtually evaporated in this country. A good chunk of the population got sucked through a financial wormhole back to the sixties.
Such are the findings of Edward Wolff, an economist at New York University who has produced a paper documenting the Chernobyl-like meltdown of asset values during the recession and its impact on wealth inequality. To some degree, his work confirms what we've already more or less known: Home prices, 401Ks, and the like were demolished during in the recession, and we've been reckoning with the consequences since. In June, the Federal Reserve released its own analysis of household finances, which found that median net worth (which just means a family's assets minus its debts) fell closer to 39 percent from 2007 to 2010. Wolff also uses Federal Reserve data while approaching the net worth calculation in a slightly different way. But his study is most valuable in that it gives us a clear sense of which families were set back and how far.
In the United States, wealth (again, what people own, minus their debts) tends to be much, much more concentrated than income (what people make). That's not particularly surprising, since the rich have extra cash to stow away in bonds, stocks, and other investments, while the rest of us spend much of our money fulfilling basic needs such as housing and transportation. The rich are frequently well off to start with because they also own pieces their own businesses, which adds to their net worth tally.
But Wolff found that during the recession, wealth inequality increased, even as incomes evened out a bit. Why? Because while middle class families saw the value of their possessions collapse dramatically, the wealthy came out comparatively unscathed. You can see that in the graph below via the difference between median (dark blue) and mean (light blue) net worth -- the former declined by about half and the latter by around 18 percent.The mean (or average) gets boosted by all those rich households.
There were two big reasons why the middle class suffered disproportionately. First, the economic crisis was first and foremost a housing crisis, and homes are by far the biggest store of wealth for most middle-class Americans (who are shown in green below). In fact, even after the housing crash, home equity still made up 66.6 percent of middle class assets -- higher than in the late 1990s.
The pain families felt from the housing crash was exacerbated by debt -- loads and loads of debt, which Wolff argues they piled up borrowing to cover everyday expenses. In 2007, middle class households owed 61 cents for each dollar of wealth they possessed, up from 41 cents in 2001 (that stat is shown as the debt-to-equity ratio, below). When the value of a house or any other asset drops, debt makes the owner's net worth fall faster than it otherwise would if they were debt free (a bit on the arithmetic in a footnote below*). Because the wealthy were never as deeply in hock as the middle class, their finances didn't suffer as much when the economy soured.
Our economy still fundamentally runs on middle class spending -- on houses, on cars, on trips to the mall -- and those families saw their finances eviscerated in a way unlike what's happened during any recession since World War II. Today, home prices have started recovering, but the bounce-back has been modest. Household debt is falling, but it's still high. Until we can fix those things, our recovery is going to move at more of a crawl than a sprint.
*Pretend your only asset in the world is a house. For the sake of argument it's worth $100 (maybe it's in Las Vegas or something). Now, let's say you own it outright, so your net worth is also $100. If home prices tumble 5 percent, so does your net worth. You have $95 to your name.
Now, let's say your house is actually $200, and you have a $100 dollar mortgage. So you still start off worth $100. When home prices fall 5 percent, your house's price is going to drop $10. Suddenly, your net worth is just $90.