The headline is dramatic. For the typical American household, net worth is down 39% from 2007 to 2010. That puts net worth for the typical household back where it was in the early 1990s. This data is from the Federal Reserve’s latest report on American finances from 2007 to 2010.
This decline is huge. And it’s no doubt largely a result of the effect of a leveraged investment in housing. When you buy an asset with leverage, a decline in prices is particularly damaging to your net equity position. For example, suppose a family owns a $100,000 house with an $80,000 mortgage (and for simplicity has no other assets or debts). The family’s net worth is $20,000, all invested in housing equity. House prices decline 20%, so the $100,000 house is now worth $80,000. As a result their net worth shrinks from $20,000 to $0—a 100% decline.
This housing math is at the heart of the 39% drop in net worth. Fed economists estimate that about three-quarters of the decline is due to the housing crisis. Of course it works in the opposite direction too. When housing prices begin to rise, net worth will jump because of leverage.
From the report, another reason for the decline appears to be the impact of financially-stressed households tapping savings. After housing (and basic bank accounts), the most widely held types of financial holdings are retirement accounts—IRAs, 401(k)s, and other flavors of these accounts. About half of American households hold retirement accounts.
According to the Fed report, from 2007 to 2010, the fraction of Americans with these accounts slipped from 53% to 50%. Median balances fell by around 7%, from $47,100 in 2007 to $44,000 in 2010. Among pre-retirees, age 55-64, median retirement balances declined by 5%, from around $105,000 to $100,000.
I doubt much of this decline in retirement accounts was due to market performance—a 70/30 mix of stocks and bonds was up over 2% over the three years.* While such a portfolio doesn’t represent the broader market, it’s certainly an interesting statistic to consider. Besides, many working households continued to contribute to their retirement accounts. More likely than not, this drop reflects some households liquidating and/or withdrawing from accounts—likely those who are unemployed for extended periods or are facing housing problems.
In our own research, we’ve seen growing 401(k) balances among workers who continue to remain employed, including over the 2007-2010 period.** This data from the Fed shows both the impact of those still saving while on the job, plus the result of those losing or changing jobs and tapping their accounts. In effect, retirement accounts have served as a form of supplemental unemployment insurance or a financial buffer for distressed households.
Much has been made of the impact of the financial crisis on retirement accounts. Yet while retirement accounts fell during the financial crisis, they rebounded more quickly—dramatically faster than housing—and so, somewhat paradoxically, have helped soften the blow from poor performing leveraged investments in housing.
For households who had to spend their accounts, this is cold comfort. But for those continuing to hold and add to their retirement accounts, the unexpected story seems to be that financial accounts served to diversify housing risk, at least partially. Perhaps the long-term lesson for households is to ensure that they don’t overinvest in owner-occupied housing, and have a large cushion of financial assets as a hedge.
Until the housing crisis, I never actually thought of financial savings in this way.
* How America Saves, 2011, p 37. Index performance based on S&P 500 and Barclays US Aggregate Indexes over the three-year period ended December 31, 2010, rebalanced to a 70/30 portfolio monthly. This example is hypothetical. Performance would vary for other portfolios over this and other time periods.
** How America Saves, 2011, Figure 42, p 37.
Notes: All investing is subject to risk. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. Diversification does not ensure a profit or protect against a loss in a declining market.