6. Household debt continues to remain high
In 2010, owner-occupied housing accounted for 31 percent of total assets (see Table 4). However, net home equity -- the value of the house minus any outstanding mortgage -- amounted to only 18 percent of total assets. Real estate, other than owner-occupied housing, comprised 12 percent, and business equity another 18 percent. Liquid assets (demand and time deposits, money market funds, CDs, and the cash surrender value of life insurance) made up 6 percent and pension accounts 15 percent. Bonds and other financial securities amounted to 2 percent; corporate stock, including mutual funds, to 11 percent; and trust equity to 2 percent. Debt as a proportion of gross assets was 17 percent, and the debt-equity ratio (the ratio of household debt to net worth) was 0.21.
There were some significant changes in the composition of household wealth over the years 1983 to 2010. First, the share of gross housing wealth in total assets, after fluctuating between 28.2 and 30.4 percent from 1983 to 2001, increased to 32.8 percent in 2007 and then fell to 31.3 percent in 2010. There are two main factors behind this – the homeownership rate and housing prices. According to the SCF, the homeownership rate, after falling from 63.4 percent in 1983 to 62.8 percent in 1989, picked up to 67.7 percent in 2001 and 68.6 percent in 2007 but then fell to 67.2 percent in 2010. Median house prices for existing homes rose by 19 percent in real terms between 2001 and 2007 but then plunged by 26 percent from 2007 to 2010. A substantial share of the movement of the proportion of housing in gross assets can be traced to these two time trends.21
Second, net equity in owner-occupied housing as a share of total assets, after falling from 24 percent in 1983 to 19 percent in 2001, rose to 21 percent in 2007 but then fell sharply to 18 percent in 2010. The difference between gross and net housing as a share of total assets can be traced to the changing magnitude of mortgage debt on homeowner's property, which increased from 21 percent in 1983 to 33 percent in 2001, 35 percent in 2007 and then 41 percent in 2010. Moreover, mortgage debt on principal residence climbed from 9.4 to 11.4 percent of total assets between 2001 and 2007 and then to 12.9 percent in 2010. The sharp decline in net home equity as a proportion of from 2007 to 2010 is attributable to the sharp decline in housing prices.
Third, relative indebtedness increased, with the debt-equity (net worth) ratio climbing from 15 percent in 1983 to 18 percent in 2007 and then to 21 percent in 2010. Likewise, the ratio of debt to total income surged from 68 percent in 1983 to 119 percent in 2007 and then to 127 percent in 2010, its high for this period. If mortgage debt on principal residence is excluded, the ratio of other debt to total assets actually fell off from 6.8 percent in 1983 to 3.9 percent in 2007 but then rose slightly to 4.5 percent in 2010. The large rise in relative indebtedness between 2007 and 2010 could be due to a rise in the absolute level of debt and/or a fall off in net worth and income. As shown in Table 1, both mean net worth and mean income fell over the three years. There was also a slight contraction of debt in constant dollars, with mortgage debt declining by 5.0 percent, other debt by 2.6 percent, and total debt by 4.4 percent. Thus, the steep rise in the debt to equity and the debt to income ratio over the three years was entirely due to the reduction in wealth and income.
A fourth change is a dramatic increase in pension accounts, which rose from 1.5 percent of total assets in 1983 to 12 percent in 2007 and then to 15 percent in 2010. There was a huge increase in the share of households holding these accounts between 1983 and 2001, from 11 to 52 percent. The mean value of these plans in real terms climbed dramatically. It almost tripled among account holders and skyrocketed by a factor of 13.6 among all households. These time trends partially reflect the history of DC plans. IRAs were first established in 1974. This was followed by 401(k) plans in 1978 for profit-making companies (403(b) plans for non-profits are much older). However, 401(k) plans the like did not become widely available in the workplace until about 1989.
From 2001 to 2007 the share of households with a DC plan leveled off and then from 2007 to 2010 the share fell modestly, from 52.6 to 50.4 percent. The average value of DC plans in constant dollars continued to grow after 2001. Overall, it advanced by 21 percent from 2001 to 2007 and then by 11 percent from 2007 to 2010 among account holders and by 22 percent and 7 percent, respectively, among all households. Thus, despite the stock market collapse of 2007-2010 and the 18 percent decline of overall mean net worth, the average value of DC accounts continued to grow after 2007. The reason is that households shifted their portfolio out of other assets and into DC accounts.
Fifth, the share of corporate stock and mutual funds in total assets rose rather briskly from 9 percent in 1983 to 15 percent in 2001, and then plummeted to 12 percent in 2007 and even further to 11 percent in 2010. If we include the value of stocks indirectly owned through mutual funds, trusts, IRAs, 401(k) plans, and other retirement accounts, then the value of total stocks owned as a share of total assets more than doubled from 11 percent in 1983 to 25 percent in 2001, tumbled to 17 percent in 2007, and then rose slightly to 18 percent in 2010. The rise during the 1990s reflected the bull market in corporate equities as well as increased stock ownership, while the decline in the 2000s was a result of the sluggish stock market as well as a drop in stock ownership.
6.1 Portfolio composition by wealth class
The tabulation in Table 4 provides a picture of the average holdings of all families in the economy, but there are marked class differences in how middle-class families and the rich invest their wealth. As shown in Table 5, the richest one percent of households (as ranked by wealth) invested over three quarters of their savings in investment real estate, businesses, corporate stock, and financial securities in 2010. Corporate stocks, either directly or indirectly owned, comprised 21 percent. Housing accounted for only 9 percent of their wealth, liquid assets 5 percent, and pension accounts 8 percent. The debt-equity ratio was only 3 percent, the ratio of debt to income was 61 percent, and the ratio of mortgage debt to house value was 19 percent.
Among the next richest 19 percent of U.S. households, housing comprised 30 percent of their total assets, liquid assets 7 percent, and pension assets 21 percent. Investment assets – non-home real estate, business equity, stocks, and bonds – made up 41 percent and 20 percent was in the form of stocks directly or indirectly owned. Debt amounted to 14 percent of their net worth and 118 percent of their income, and the ratio of mortgage debt to house value was 30 percent.
In contrast, almost exactly two thirds of the wealth of the middle three quintiles of households was invested in their own home in 2010. However, home equity amounted to only 32 percent of total assets, a reflection of their large mortgage debt. Another 20 percent went into monetary savings of one form or another and pension accounts. Together housing, liquid assets, and pension assets accounted for 87 percent of total assets, with the remainder in investment assets. Stocks directly or indirectly owned amounted to only 8 percent of their total assets. The debt-equity ratio was 0.72, substantially higher than that for the richest 20 percent, and their ratio of debt to income was 135 percent, also much higher than that of the top quintile. Finally, their mortgage debt amounted to a little more than half the value of their principal residences.
Almost all households among the top 20 percent of wealth holders owned their own home, in comparison to 68 percent of households in the middle three quintiles. Three-quarters of very rich households (in the top percentile) owned some other form of real estate, compared to 49 percent of rich households (those in the next 19 percent of the distribution) and only 12 percent of households in the middle 60 percent. Eighty-nine percent of the very rich owned some form of pension asset, compared to 83 percent of the rich and 46 percent of the middle. A somewhat startling 74 percent of the very rich reported owning their own business. The comparable figures are 30 percent among the rich and only 8 percent of the middle class.
Among the very rich, 89 percent held corporate stock, mutual funds, financial securities or a trust fund, in comparison to 61 percent of the rich and only 15 percent of the middle. Ninety-five percent of the very rich reported owning stock either directly or indirectly, compared to 84 percent of the rich and 41 percent of the middle. If we exclude small holdings of stock, then the ownership rates drop off sharply among the middle three quintiles, from 41 percent to 29 percent for stocks worth $5,000 or more and to 24 percent for stocks worth $10,000 or more.
The rather staggering debt level of the middle class in 2010 raises the question of whether this is a recent phenomenon or whether it has been going on for some time. Table 6 shows the wealth composition for the middle three wealth quintiles from 1983 to 2010. Houses as a share of assets remained virtually unchanged from 1983 to 2001 but then increased from 2001 to 2010. It might seem surprising that despite the steep drop in home prices from 2007 to 2010, housing as a share of total assets actually increased slightly. The reason is that the other components of wealth fell even more than housing. While housing fell by 30 percent in real terms, other real estate was down by 39 percent, liquid assets by 48 percent, and stocks and mutual funds by 47 percent.
Pension accounts rose as a share of total assets by almost 13 percentage points from 1983 to 2010 while liquid assets declined as a share by 16 percentage points. This set of changes paralleled that of all households. The share of all stocks in total assets mushroomed from 2.4 percent in 1983 to 12.6 percent in 2001 and then fell off to 8.2 percent in 2010 as stock prices stagnated and then collapsed and middle class households divested themselves of stock holdings. The proportion of middle class households with a pension account surged by 41 percentage points between 1983 and 2007 but then fell off sharply by almost 8 percentage points in 2010.
Changes in debt, however, represent the most dramatic movements. There was a sharp rise in the debt-equity ratio of the middle class from 0.37 in 1983 to 0.61 in 2007, with all of the increase occurring between 2001 and 2004, a reflections mainly of a steep rise in mortgage debt. The debt to income ratio more than doubled from 1983 to 2007. Once, again, much of the increase happened between 2001 and 2004. The rise in the debt-equity ratio and the debt to income ratio was much steeper than for all households. In 1983, for example, the debt to income ratio was about the same for middle class as for all households but by 2007 the ratio was much larger for the middle class.
Then, the Great Recession hit. The debt-equity ratio continued to rise, reaching 0.72 in 2010 but there was actually a retrenchment in the debt to income ratio, falling to 1.35 in 2010. The reason is that from 2007 to 2010, the mean debt of the middle class in constant dollars actually contracted by 25 percent. There was, in fact, a 23 percent reduction in mortgage debt as families paid down their outstanding balances, and an even larger drop in other debt of 32 percent as families paid off credit card balances and other forms of consumer debt. The steep rise in the debt-equity ratio of the middle class between 2007 and 2010 was due to the sharp drop in net worth, while the decline in the debt to income ratio was almost exclusively due to the sharp contraction of overall debt.
As for all households, the ratio of net home equity to assets fell for the middle class from 1983 to 2010 and mortgage debt as a proportion of house value rose. The decline in the ratio of net home equity to total assets between 2007 and 2010 was relatively small despite the steep decrease in home prices, a reflection of the sharp reduction in mortgage debt. On the other hand, the rise in the ratio of mortgage debt to house values was relatively large over these years because of the fall off in home prices.
6.2 The “middle class squeeze”
Nowhere is the middle class squeeze more vividly demonstrated than in their rising debt. As noted above, the ratio of debt to net worth of the middle three wealth quintiles rose from 0.37 in 1983 to 0.46 in 2001 and then jumped to 0.61 in 2007. Correspondingly, their debt to income rose from 0.67 in 1983 to 1.00 in 2001 and then zoomed up to 1.57 in 2007. This new debt took two major forms. First, because housing prices went up over these years, families were able to borrow against the now enhanced value of their homes by refinancing their mortgages and by taking out home equity loans. In fact, mortgage debt on owner-occupied housing (principal residence only) as a proportion of total assets climbed from 29 percent in 1983 to 47 percent in 2007, and home equity as a share of total assets fell from 44 to 35 percent over these years. Second, because of their increased availability, families ran up huge debt on their credit cards.
Where did the borrowing go? Some have asserted that it went to invest in stocks. However, if this were the case, then stocks as a share of total assets would have increased over this period, which it did not (it fell from 13 to 7 percent between 2001 and 2007). Moreover, they did not go into other assets. In fact, the rise in housing prices almost fully explains the increase in the net worth of the middle class from 2001 to 2007. Of the $16,400 rise in median wealth, gains in housing prices alone accounted for $14,000 or 86 percent of the growth in wealth. Instead, it appears that middle class households, experiencing stagnating incomes, expanded their debt in order to finance normal consumption expenditures.
The large build-up of debt set the stage for the financial crisis of 2007 and the ensuing Great Recession. When the housing market collapsed in 2007, many households found themselves “underwater,” with larger mortgage debt than the value of their home. This factor, coupled with the loss of income emanating from the recession, led many home owners to stop paying off their mortgage debt. The resulting foreclosures led, in turn, to steep reductions in the value of mortgage-backed securities. Banks and other financial institutions holding such assets experienced a large decline in their equity, which touched off the financial crisis.