Bankruptcy

Wealth Destruction by the Numbers

By Christian E. Weller

Financial markets went into free fall in late September and early October. The third quarter of 2008 continued the wealth destruction that took place in the previous nine months. This wealth decline is large, broad, and quick.

The primary reason for wealth building is retirement. Many families nearing retirement, though, relied primarily on their homes for their retirement income. According to the Federal Reserve, only 62.9% of families between the ages of 55 and 64, had a retirement account, such as a 401(k) or IRA, in 2004. The typical holding in such accounts was $83,000 in 2004 dollars. In comparison, 79.1% of such families owned their own house with a total typical value of $200,000. In other words, policymakers need to take a comprehensive view at restoring family wealth in an effort to strengthen retirement income security. Much of the policy attention has been on protecting housing wealth. Policy responses, though, need to match the problem, specifically by fostering a pension renaissance and by vastly improving existing retirement savings plans in addition to protecting housing wealth.

Calculations based on data from the Federal Reserve show that the decline in household wealth was very large. In inflation adjusted 2008 dollars, total household wealth fell by $4.5 trillion from September 2007, the last wealth peak, to June 2008. Included in this total wealth loss was a drop of home equity by $1 trillion. Also, total wealth in pension plans ? traditional defined benefit pensions, pension plans for state and local government employees, pension plans for federal employees, and retirement savings plans, such as 401(k) plans ? fell by $1.2 trillion during those nine months.

It is especially important to consider total wealth relative to disposable income. Total wealth is a store of future income that can be used to replace income, for instance, in the case of retirement. Relative to disposable income, wealth has also dropped sharply. Total wealth amounted to 517.4% of disposable income in the second quarter of 2008, the lowest level since September 2003. Also, financial wealth totaled 275.8% of disposable income in June 2008, which was also the lowest level since September 2003. More dramatically, though, home equity fell to 81.2% of disposable income in June 2008, the lowest level since December 1976.

The drop in household wealth was very fast. For instance, the decline in real total household wealth was an annualized average loss of 10.2% for the three quarters from September 2007 to June 2008. In comparison, during the first three quarters of the downturn in the early 2000s, from March 2000 to December 2000, the rate of decline averaged to an annualized 6.8% and for the entire wealth loss streak from March 2000 to September 2002 it averaged to 7.1%. That is, the current wealth loss is more than 40% faster than during the last period of wealth loss.

The loss in housing wealth was even more breathtaking. Home equity shrank at an annualized average rate of 17.8% from September 2007 to June 2008. This was the second highest drop in real home equity over a three quarter period on record and the largest such decline since the first three quarters of 1974.

Against this backdrop, it is tantamount for policymakers to focus not only on protecting housing wealth, but also help to build other forms of retirement wealth, e.g. by encouraging a pension renaissance and by vastly improving retirement savings plans, such as 401(k) plans.

Full post as published by Credit Slips on October 13, 2008 (boomark / email).