How the Financial Crisis Drastically

Increased Wealth Inequality in the US

We live in unequal times. The causes and consequences of widening disparities in income and
wealth have become a defining debate of our age. Researchers have made major inroads into
documenting trends in either income or wealth inequality in the United States, but we still know
little about how the two evolve together — an important question to understand the causes of
wealth inequality.

We do know that asset prices have been a key determinant of inequality in postwar America,
based on our recent research. Although income inequality has been on the rise for decades,
wealth inequality hadn’t changed much until more recently. Why not?

Our research demonstrates that wealthier and less-wealthy people own different types of assets:
the middle class has a higher share of its wealth in housing, whereas the rich own more stock. An
important consequence of this finding is that housing booms lead to wealth gains for leveraged
middle-class households and tend to decrease wealth inequality. Stock market booms primarily
boost the wealth at the top of the wealth distribution where portfolios are dominated by listed and
unlisted business equity, thereby, increasing wealth inequality. The existence of these different
portfolios means that wealth inequality is essentially a race between the housing market and the
stock market. Over extended periods in postwar American history, that race has been the
predominant driver of shifts in the U.S. distribution of wealth.

Our research required substantial preparatory work because data to study this question over the
long run did not exist. We overcame this challenge by compiling the Historical Survey of
Consumer Finances (HSCF) — new data for long-run inequality research in the United States.

With the dataset in hand, we first documented that investment portfolios differ systematically
along the wealth distribution. While the portfolios of rich households are dominated by corporate
and non-corporate equity, the portfolio of a typical middle-class household is highly
concentrated in residential real estate and, at the same time, highly leveraged. These portfolio
differences are very persistent over time.

This pattern implies that asset price changes shape the wealth distribution and can decouple
trends in income and wealth inequality for extended periods of time. When asset prices rise,
wealth grows even without savings by households, and hence, can compensate for the effects that
low income growth and declining savings rates have on wealth accumulation. We document that
such a decoupling existed for the four decades before the Financial Crisis. During that time, the
middle class rapidly lost ground to the top 10% with respect to income but, by and large,
maintained its wealth share thanks to substantial gains in housing wealth. While incomes of the
top 10% more than doubled since 1971, the incomes of middle-class households increased by
less than 40% and incomes in the bottom 50% stagnated in real terms. When it comes to wealth,
the picture is different. For the bottom 50%, wealth doubled between 1971 and 2007 despite zero
income growth. For the middle class and the top 10%, wealth grew at approximately the same
rate, rising by a factor of 2.5 resulting in a decoupling of income and wealth inequality for 40
years.

For the bottom 90%, asset price changes were particularly important, accounting for the
dominant part of their wealth growth before the start of the global crisis in 2008. We estimate
that between 1971 and 2007, the bottom 50% had wealth growth of 97% purely because of asset
price changes — essentially their wealth doubled before taking into account any saving. The
upper half of the distribution registered wealth gains of roughly 60% because of rising asset
prices. Politically, it’s conceivable that these large wealth gains for the middle- and lower-middle
class helped to dispel discontent about stagnant incomes for some time.

Then the financial crisis happened. When house prices collapsed in 2008, the value of middle-
class households’ portfolios dropped substantially, while the quick rebound in stock markets
boosted wealth at the top. Due to their heavy investment in equities, the top 10% wealthiest
households were the main beneficiary from the stock market boom while being at the same time
relatively less affected by the drop in residential real estate prices. The consequence of
substantial wealth losses at the bottom and in the middle of the distribution coupled with wealth
gains at the top produced the largest spike in wealth inequality in postwar American history. And
without housing prices keeping Americans’ wealth growing, the rising inequality that had been
happening in income for decades was suddenly much more noticeable.

Our research also studies the racial divide in wealth. When it comes to the financial situations of
households in the U.S., race remains a major dividing line. The HSCF data provide a new
perspective on the long-run evolution of racial wealth inequality, which had been uncharted
territory until now, as long-run data were simply not available.

Racial disparities in income today are as big as they were in the pre-civil rights era. In 1950, the
income of the median white household was about twice as high as the income of the median
black household. In 2016, black household income is still only half of the income of white
households. The racial wealth gap is even wider than the income gap and is still as large as it was
in the 1950s and 1960s. The median black household has less than 15% of the wealth of the
median white household. The financial crisis has hit black households particularly hard and has
undone the little progress that had been made in reducing the racial wealth gap during the 2000s.
The overall summary is bleak. We document that over seven decades, next to no progress has
been made in closing the black-white income gap. The racial wealth gap is persistent and a stark
fact of postwar America. The typical black household remains poorer than 80% of white
households.

Changes in American wealth inequality over the last 70 years were dominated by a race between
the stock market and the housing market. Our results suggest that asset price dynamics and
portfolio allocation should enter the center stage for the future research on the sources and
dynamics of wealth inequality. And the financial crisis should be considered a definitive moment
in the rise of wealth inequality within America.

Moritz Kuhn, Moritz Schularick, and Ulrike Steins

September 13, 2018