Making Sure Money Is Available When We Need It

7/29/2019 Making Sure Money Is Available When We Need It

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Making Sure Money Is AvailableWhen We Need It

Protecting Household Assets Must Become an Integral Part o USavings Policies

Christian E. Weller March 2013

WWW.AMERICANPROGRESS.O


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Making Sure Money IsAvailable When We Need ItProtecting Household Assets Must Become an Integral

Part o U.S. Savings Policies

Christian E. Weller March 2013


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1 Introduction and summary

5 Greater wealth volatility has led to rising risk exposure

11 Risk exposure has increased over time and across group

16 Detailed data show that risk exposure has become exces

24 Conclusion and policy implications

28 About the author

29 Appendix A: Review of the relevant literature on wealth

risk exposure

31 Appendix B: High wealth went along with high insecurit

before the crisis

32 Appendix C: Indicators of individual risk exposure

36 Appendix D: Rising risk exposure over time and changing

exposure during crises

38 Endnotes

Contents


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1 Center or American Progress | Making Sure Money Is Available When We Need It

Introduction and summary

Household wealhhe dierence beween a households asses and is debis

a crucial aspec o economic securiy. I allows households o pay or necessiies

during an economic emergency, and i permis amilies o inves in heir uure

pay or heir childrens or heir own educaion, sar a business, swich jobs, move

o advance heir careers, and plan or a secure reiremen.

For a amily o bene rom i, household wealh has o acually be here when

households need he economic securiy ha comes rom having wealh. Overhe pas ew decades, however, household wealh has become increasingly

volaile, meaning ha wealh has swung up and down much more widely over

he pas wo decades han i did in he preceding decades aer World War II.1

Macroeconomic insabiliy due o he housing and sock marke bubblesand

burssis one o he conribuing acors, bu so is greaer household-wealh

risk exposure due o more invesmens in he housing and sock markes and

greaer household deb han in he pas.

Some risk in household wealh is unavoidable; wealh will always ucuae some-

wha due o household risk exposure in he sock and housing markes and deb.

Bu amilies need o beter manage heir risk exposure o make sure ha hey can

rely on heir wealh when hey need i. Household-wealh risk capures he unpre-

dicabiliy o uure incomes ha are derived rom household wealh. Financial

markes, especially hose or socks and housing,2 will always be subjec o sub-

sanial ups and downs and will hus enail risk. Households could, in heory, buy

insurance o proec hemselves rom nancial risk, bu insurance producs can

be cosly and ineecivei, or example, he insurance companies ail jus when

nancial markes crash. Te alernaive is or households o manage heir risk in

such a way ha hey ake advanage o poenial invesmen upsides while keepinghe downsides o an accepable level. Households, or insance, could mainain a

seady allocaion o heir asses in he sock and housing markes by selling socks

when prices rise and invesing more in he markes as prices all.


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Poorly managed risk could resul in excessive wealh volailiy andulimaely

in less wealh han would be he case wih well-managed nancial risk. Firs,

increased wealh volailiy likely reduces he amoun ha households save. Tis

is because households reac o rapidly rising wealh by saving less or borrowing

more so ha hey can spend more on hings such as ood and clohing han hey

have in he pas. Tis is known as he wealh eec, when households believehey have more money on paper han hey acually have. Bu when a marke

correcion occurs and wealh suddenly decreases, households oen canno save

enough moneyor shed deb quickly enougho make up or heir losses.

Second, greaer wealh volailiy makes i harder or households o plan and save

or heir uure. When aced wih greaer wealh volailiy, households have a

harder ime predicing how much money hey will be able o rely on or reire-

menwhich is he main reason people save money. Households are le guessing

wha heir uure reiremen income will be, and heir guesses can become increas-

ingly inaccurae i heir wealh ucuaes more as hey ge closer o reiremen.Some households will reire oo earlyin oher words, hey will have a lo less

money in reiremen han hey hough hey would have, lowering heir sandard

o living in reiremen. Alernaively, some households will reire much laer or

save more and spend subsanially less han hey did beore reiring. Less spending

by reirees, hough, could slow overall economic growh.

Tird, greaer wealh volailiy also means ha people will be unhappier han hey

would be i hey managed heir risk well. Tey will eel more anxious abou heir

nancial uure and hus buckle down, invesing less in long-erm projecs such as

saring a business, sending heir kids o college, and swiching o careers where

heir skills are a beter . Tey will pu heir money ino cash accouns insead

o invesing i, hey will no save enough money o pay or heir childrens college

educaion, and hey will say in jobs ha no longer adequaely heir skillsand

again, households end up wih lower sandards o living over ime.

Tis repor considers daa on household wealhand paricularly, household-

level daa or older nonreirees3o see i household risk exposure, on average,

has become excessive and i policymakers should hereore consider encouraging

beter risk managemen sraegies or savers. Te comparison o household riskexposure over imespecically, rom 1989 o 2010and beween household

groups can provide a general indicaion o wheher risk has been more poorly

managed in recen years, hus becoming excessive.4


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Te rs indicaion ha risk has become excessive is ha he amoun o wealh

over ime has no rended upward. Well-managed risk would have allowed house-

holds, on average, o reap he upsides o booming markes wihou losing heir

shirs in he down markes. Wealh-o-income raiosa ypical measure o eco-

nomic securiy, since wealh is inended o replace income once i disappears

should have hereore rended upward over ime.5

Te evidence shows, however,ha wealh-o-income raios were essenially a rom 1989 o 2010, alhough

hey have ucuaed much more han in he pas.

Second, risk exposure beween household groups should have converged over

ime. Financial-marke changesespecially greaer access o individual inves-

mens hrough reiremen savings accouns, broader access o credi markes

due o regulaory changes, lower coss o invesing due o increased compeiion,

and lower ineres raes as inaion has declinedshould have made i easier or

households o manage heir risk. Te gap beween hose groups o households

ha had high levels o risk exposure and hose who had low levels o risk exposurein 1989 should have declined by 2010. Te household-level daa, however, shows

no convergence in household risk exposure. In ac, he gap widened depending

on some household characerisics such as race and ehniciy.

Tird, household risk exposure should have allen during marke crises, when

asse prices all and access o deb declines, lowering he exposure o urher

asse-price declines in he uure. Te Unied Saes experienced hree subsanial

economic and nancial crises beween 1989 and 2010he savings and loan

indusry crisis ha ook place in he lae 1980s, he bursing o he docom bubble

coupled wih he recession o 2000 o 2001, and he burs o he housing bubble

in 2007 coupled wih he Grea Recession o 20072009. Crises are periods o

subsanial nancial and economic urmoil ha make i harder or households o

properly manage heir risk exposure. In oher words, exernal rendssock- and

house-price changes, as well as debdominae wha happens o household risk

exposure, bu no necessarily how households make decisions. All exernal rends

should primarily decrease during a crisis, as sock and house prices all and access

o credi declines. Household risk exposure should hereore decline as acual

risk maerializes because risky asse prices all, making i harder o go ino deb

and allowing households o save. Te daa analyzed in his repor sugges harisk exposure did no acually all during he hree crises ha have occurred since

1989and ha households may have, in ac, been exposed o more risk as risk

maerialized, which has possibly se he sage or he nex boom and bus cycle.


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Fourh, household risk exposure beween he crises should have been relaively

sable. According o he daa, here were wo periods o sabiliy beween he hree

crises: one lasing rom 1992 o 1998 and he oher lasing rom 2001 o 2007.

Tese should have been periods o less economic and nancial urmoil han he

crisis periods, which should have made i easier or households o manage heir

risk exposure. Household risk exposure, hereore, should have been relaivelysable beween crises, a leas in he aggregae. Te daa sugges, however, ha

household risk exposure grew, especially in he later period.

Te daa on household risk exposure sugges ha household risk was no man-

aged well rom 1989 o 2010 and ha here is room or policymakers o encourage

beter sraegies o manage household risk as par o incenivizing he public o

save more money. Beter risk-managemen sraegies include greaer ransparency

o nancial risks o households, more accessible risk disclosure or households,

and more comprehensive risk disclosure in nancial saemens o households.

Policymakers can also sugges more regulaory and nancial incenives by, orexample, promoing model invesmen porolioswhereby he raio o risky

asses says consan over imeand sae invesmenssuch as reasury Inaion

Proeced Securiies and lie insurance annuiies, among oher sraegies.

I is ime o sar addressing rising household risk exposure. Policies address-

ing household risk exposure have changed litle in he aermah o he Grea

Recession: Requiremens or risk disclosure are sill limied and complex, and

here is sill only some regulaory relie or employers who oer sae invesmens

wih some rae o reurn as deaul invesmens in heir 401(k) plans, among

oher hings. Tere are already signs ha household risk exposure may rise again,

especially because banks sopped ighening lending sandards or morgages and

oher key orms o consumer deb in 2010.6


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Greater wealth volatility has led

to rising risk exposure

Privae wealh is a key measure o income securiy. Wealh is he sore o income

ha households can draw upon o replace heir aer-ax income when heir

income shrinksin, or insance, an economic emergency or upon reiremen.

Tis repor hereore uses wealh relaive o aer-ax income o capure rends o

average economic securiy over ime. Tis raio gives a sense o how wealh has

changed relaive o wha i is mean o replace: curren income. Te advanage o

his raio is ha i is economically meaningul; he disadvanage is ha i is harder

o inerpre han, or insance, a dollar amoun o household wealh.

Reiremen is he primary reason ha people save money.7 Middle-class seniors

ge a basic income guaranee rom Social Securiy upon reiremen, bu hese

benes can only do so much, and many reirees require addiional income rom

pensions and heir own savings o mainain a middle-class liesyle. Te savings

necessary o pay or his addiional income during reiremen can be subsanial,

as a simple example demonsraes: A couple in which boh spouses receive aver-

age earnings subjec o Social Securiy axaion would reire a age 65 in 2010

wih a combined annual income o $82,118 immediaely beore reiremen.8 Tey

would, upon reiring, receive 40.8 percen o ha $82,118 rom Social Securiy.

Following he rule o humb ha reirees need abou 75 percen o 80 percen o

heir prereiremen earnings, o mainain heir sandard o living aer hey reire,

his means ha he couple would need anoher approximaely 35 percen o 40

percen o he $82,118or beween $28,741 and $32,847 in annual income plus

inaiono come rom privae savings each year. Tis hypoheical wo-earner

couple would hereore need o have saved $422,000 in wealh when hey reired

in 2010 o las hem 18 years.9 Tis is subsanially more han mos middle-class

households have saved.10

Te raio o wealh o aer-ax income shows increasingly large swings over ime.11

Household wealh o aer-ax income rs peaked a 507.9 percen in December

1958, evenually alling o 439.1 percen in June 1970a drop o 68.9 percen-

age poins in a litle less han 12 years. Te raio gradually increased again hrough


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June 1995 beore i rapidly climbed o a peak o 618.6 percen in March 2000.

Te burs o he Inerne bubble reduced he raio o wealh o aer-ax income o

507.3 percen in Sepember 2002, and he subsequen sock- and housing-marke

bubbles brough he raio back up o 651.8 percen in March 2006. Wealh o

aer-ax income hen ell drasically o a low o 477.5 percen in March 2009. Te

raio hus swung up and down wice by more han 100 percenage poins rommid-1995 o mid-2007, dwarng he changes ha occurred beore 1995.12

Wealh losses have become progressively worse since he lae 1980s, considering

wha happened o household wealh during he mos recen hree criseshe

savings and loan crisis o he lae 1980s, he bursing Inerne bubble and reces-

sion o he early 2000s, and he housing crisis in 2007 coupled wih he Grea

Recession ha occurred rom 2007 o 2009.13 From December 1989 o Sepember

1990, he raio o wealh o aer-ax income ell by 25.6 percenage poinsa

quarerly average drop o 8.5 percenage poins. From March 2000 o Sepember

2001, i ell by a oal o 68.6 percenage poinsa quarerly average drop o 13.7percenage poins. And rom June 2007 o March 2009, i ell by 171.4 percenage

poinsa quarerly average all o 24.5 percenage poins.14

Tis increasing volailiy in household wealh goes hand in hand wih increased

risk exposure.15 Financial riskso which a households savings can be exposed

reer o he uncerainy o uure wealh and hereore uure income. Greaer risk

means greaer up-and-down gaps beween he botom and he op o nancial

markes over ime. Households experience risk only i hey have risk exposure.

As discussed in deail below, risk exposure has risen over ime. Households have

experienced large up-and-down movemens o heir wealh since he lae 1980s

because here has been more risk in he marke and because hey have been

increasingly exposed o hose risks.

Household risk exposure parly depends on leverageypically he raio o

deb o asses. Leverage ranslaes ino risk exposure because asse gains and

losses are magnied.

Tis is bes shown wih a simple example. ake a household ha buys a home val-

ued a $100,000 wih a down paymen o $10,000 and a morgage o $90,000. Tehousehold now has equiy equal o $10,000 in is homehis is he households

wealh. Now assume ha he homes value alls by 10 percen. Te home price

drops o $90,000, bu he home equiy ges wiped oua loss o 100 percen

since he household sill owes a morgage o $90,000. Te loss o he household


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is 10 imes larger100 percenhan he price decline o 10 percen because

he assehe homeell in value bu he ousanding deb sayed he same. Te

more highly leveraged a householdhe larger he raio o deb o assesand

he greaer he risk o losing subsanial shares o wealh rom comparaively

smaller drops in asse price. Te opposie is also rue when asse prices go up, as

more leverage ranslaes ino greaer gains.

Tis repor hence uses he share o deb o asses, or leverage, as anoher measure

o risk exposureone in which a larger raio o deb o asses indicaes more

leverage and hence more vulnerabiliy o drops in asse values.16

Risk exposure also sems rom invesmen in risky assesspecically, in socks

and housing. Boh housing and socks come wih subsanial risksspecically,

he risks o a all in value and less income in he uure han households had

originally planned.17 Home and sock prices depend on demographic changes,

changing preerences, and rising unemploymen, and boh will all when demandweakens due o hese hree acors. Less demand or housing means lower rens

and hus less income due o oregone ren o he homeowner, whereas less

demand or socks ranslaes ino lower sales, less income, and ewer dividends

or sock owners. Consequenly, his repor uses he share o socks and housing

asses as a par o oal household asses as anoher risk-exposure measure.18

Rapidly rising household debt

o some degree, greaer wealh volailiy resuled rom greaer household deb.

Deb growh rs acceleraed in he mid-1980s; i acceleraed again aer he 2001

recession. (see Figure 1) Deb o aer-ax income, or insance, grew a a relaively

high quarerly average rae o 0.6 percenage poins, driving households quickly

ino deb and slowing he growh o heir wealh rom December 1982when

he recession endedo December 1989when he nex crisis sared.19 Tis

is double he deb-o-aer-ax income growh ha occurred rom he end o

he recession in June 1954 o he sar o he recession in June 1980.20 Te raio

o deb o aer-ax income expanded again a a quarerly rae o 0.2 percenage

poins rom March 1991he end o he recessiono March 2000he sar ohe nex crisis. Te raio o deb o aer-ax income hen acceleraed again, grow-

ing an average o 1.3 percenage poins each quarer rom he end o he recession

in December 2001 o he sar o he nex crisis in June 2007. In oher words, deb

expanded mainly in he 1980s and aer 2001.


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Te rise in deb aer 1982 and hrough 2000 is due o a number o key economic

acors. Tese include declining ineres raes, greaer use o home-equiy lines o

crediwhereby he equiy in a home serves as collaeral or he line o credi

increased nancial-marke deregulaion, and greaer nancial-marke compeiion.21

Te rapid increase in deb aer he recession ha ended in November 2001 likelyollowed slighly dieren rends. Ineres raes coninued o allbu a a much

slower pace han in he 1980s and 1990s. Home values, however, increased a an

unprecedened pace aer 2000

because households had more

collaeral o borrow agains due

o he boom in housing prices.

And households demand

or credi likely wen up due

o slow income growh amid

comparaively slow employ-men growh. Finally, nancial-

marke deregulaion coninued

during he same period, allow-

ing or he prolieraion o more

credi producs o more diverse

populaion groups.22

Te Grea Recession o 2007

2009 saw he rs susained

deb decline on record due o

a massive wave o morgage

oreclosures. Te deb-o-

aer-ax-income raio ell

rom a high o 129.3 percen

in Sepember 2007 o 116.5 percen in December 2010. (see Figure 1) Bu even

aer years o deleveragingdeclining levels o deb relaive o household income

in he wake o massive numbers o oreclosureshousehold deb levels were sill

comparaively high.

FIGURE 1

Household debt to after-tax income, 19522012

0

20%

40%

60%

80%

100%

120%

140%

March

1952

March

1962

March

1972

March

1982

March

1992

March

2002

M

Percent of after-tax income

Note: Figures are in percent o disposable ater-tax personal income.

Source: Authors calculations based on: Board o Governors, Federal Reserve, Release Z.1 Flow o Funds Accounts o the United Stat


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Higher concentration of risky assets

Wealh has also become more volaile due o a rising concenraion o risky asses,

especially socks and housing.23 Tis is shown as a share o oal household asses

in Figure 2. Te share o risky asses grew rom he mid-1970s hrough 2007,

largely ollowing he general patern o boh sock and housing prices. Te shareo risky asses ell dramaically during he Grea Recession, in large par because

sock and housing prices dropped.

Te concenraion o risky asses ypically rose jus beore he onse o crises. Te

share o risky asses rose by a quarerly average rae o 0.1 percen rom he end

o he recession in December 1982 o he sar o he crisis in December 1989; by

0.4 percenage poins each quarer rom he end o he recession in March 1991 o

he sar o he crisis in March

2000; and by 0.02 percen-

age poins each quarer romDecember 2001 o June 2007.

Te share o risky asses ell dur-

ing he crisesby 0.6 percen-

age poins each quarer in he

lae 1980s, by 0.7 percenage

poins each quarer in he early

2000s, and by 1.6 percenage

poins each quarer in he lae

2000s.24 Tis means ha house-

holds did no ully compensae

or he drop in prices by buying

more socks and homes in order

o mainain a relaively sable

raio o risky asses in heir

porolios.

Tis patern o risky-asse

concenraion suggess hahouseholds risk exposure is

driven more by marke orces

han individual decisions. Households should move away rom risky asses as

heir prices rise because he chance o a sharp downward correcion increases.

FIGURE 2

Share of housing and stocks out of household assets, 19522012

400%

450%

500%

550%

600%

650%

700%

March

1952

March

1962

March

1972

March

1982

March

1992

March

2002

Percent of after-tax income

Notes: Figures are in percent o total household assets. Risky assets include residential real estate and stocks owned both direindirectly. The calculation assumes that the average share o stocks out o all mutual-und assets and pension reserves holds s

or the household sector.

Source: Authors calculations based on Board o Governors, Federal Reserve System, Release Z.1 Flow o Funds Accounts o th

United States (2012).


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Tey should inves more in risky asses as prices all because he chance o sharp

upward movemens rises. Bu in realiy, however, he opposie happened: Te

rends in risky-asse concenraion appear o ollow marke-price movemens,

suggesing ha households did no ypically rebalance heir porolio o mainain

a relaively consan share o risky asses over ime. Tis share would be relaively

consan i households had sold more risky asses when prices were high andbough more risky asses when prices were low. I households did no regularly

rebalance heir enire asse porolio, hough, he end resul would be a buy high,

sell low sraegy.

Te problem o households risk exposure moving up and down wih he prices

o risky asses may have become worse over ime. Tis is largely a resul o a shi

rom dened-bene pension planswhere asses are proessionally managed on

behal o householdso dened-conribuion reiremen-savings plans, where

households ypically manage heir own asse allocaions. Few households seem

o acively rebalance heir porolios in dened-conribuion plans, even whenhe prices o socksand hereore he allocaion o reiremen savings in risky

asseschanges drasically.25


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Risk exposure has increased over

time and across groups

Te aggregae daa highligh a growing risk exposure or American households

due o a greaer risky-asse concenraion and growing leverage. Te remainder

o he repor uses household daa rom 1989 o 2010 o deail risk exposure or

groups o older households over ime.26 Te demographic groupings include age,

reiremen saus, marial saus, race, and ehniciy, while he economic groupings

include income and dened-bene pension coverage.27

Tis analysis only considers households ha are headed by someone 50 years oage or older who is no ye reired. Te circumsances and behaviors o younger

households can change drasically over ime, making conclusions abou individual

risk exposure oo unreliable.

Te summary daa also analyze risk exposure or hose households ha can expec

benes rom a dened-bene pension and hose ha canno. Reiremen sav-

ings come rom Social Securiy, dened-bene pensions, and individual savings.

Households should be able o wihsand more risk in heir individual savings

i hey have more securiy rom Social Securiy and heir pensions. Almos all

households can expec some reiremen benes rom Social Securiy.28 Having a

dened-bene pension, hen, can be a key disincion beween households and

he amoun o economic securiy ha hey can expec in reiremen.

Very high risk exposure grows over time for middle-class

preretirees

Tis repor rs calculaes he share o households wih very high risk exposure o

show a summary o rends and dierences across groups. Tis is only inended oprovide a concise bu rough approximaion o risk-exposure rends and compari-

sons. Te subsequen secions o his repor oer more deailed inormaion on

household risk exposure, broken down by risky-asse concenraion and leverage.


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A household is dened as having very high risk exposure i is raio o deb o

asses is greaer han 25 percen and he concenraion o socks and houses

wihin is asse porolio is greaer han 75 percen.29 Tis combined measure

hus capures wo separae aspecs o risk exposure: he concenraion o asses in

invesmens ha are subjec o subsanial price ucuaions and leverage, which

could exacerbae such price movemens. Te measure avoids double couning,even hough i includes wo disinc aspecs o homeownershiphe value, or

insance, o a house and he value o any ousanding morgage.

Tis indicaor o very high risk exposure is no a scienically designed index bu

raher an easily undersandable indicaor o wheher households will be on he

ail end o he disribuion o risky-asse concenraion and he disribuion o

household deb. Te conclusions derived rom his indicaor abou rends in risk

exposure and in comparisons beween groups are no very sensiive o changes

in he hresholds or high risky-asse concenraion and high leverage. In oher

words, dening very high risk exposure as having a deb-o-asse raio greaer han20 percen and a risky-asse concenraion greaer han 90 percen, or insance,

does no change he conclusion ha risk exposure has become excessive.

able 1 presens he average share o households wih very high risk exposure,

which sood a 23.7 percen in 2010. Nonwhies, Hispanics, younger house-

holds, married couples, households in he hird and ourh income quinile, and

households wihou dened-bene pensions had larger shares o very high risk

exposure han heir respecive counerpars. More han a quarer o all households

in he hird and ourh income quinile, or insance, had very high risk exposure

in 2010he rs ull year aer he Grea Recession endedcompared o 17.1

percen in he botom quinile and 13.5 percen in he op quinile.

Tese dierences reec populaion dierences prior o he Grea Recession.

Te share o all households wih very high risk exposure was 22.6 percen ha

year. Te dierences in very high risk exposure in 2007 by household charac-

erisics mirror he dierences in 2010. Bu in 2007, 31.6 percen o nonwhie

households had very high risk exposurehe larges share o households wih

such exposure. (see able 1)


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TABLE 1

Share of households with very high risk exposure, by selected household

characteristics and by selected years

Variable 1989 1992 1998 2001 2007 2010

1989 to

1992

1998 to

2001

2007 to

2010

1989 to

2007

19

2

Total 11.9% 13% 18.9% 17.3% 22.6% 23.7% 1.2% -1.6% 0.4% 8.3%

White 11.1% 11.3% 18.5% 15.8% 20.3% 22.7% 0.6% -1.8% 1.8% 6.7%

Non-white 14.5% 19.9% 20.6% 24% 31.6% 27% 3.3% -0.9% -5.1% 14.2%

Non-Hispanic 11.4% 12% 18.4% 16.9% 22% 23.3% 1% -1.2% 0.6% 8.4%

Hispanic 19.7% 31.1% 26.3% 24.3% 33.6% 28.9% 3.8% -7.2% -1.9% 5.6%

50 to 64, not retired 13.6% 15% 22% 19.4% 24.7% 25.5% 1.8% -2.5% 0.1% 8.8%

65 plus, not retired 7.8% 7.7% 7.3% 9.7% 10.7% 14.1% -0.7% 2.3% 1.9% 3.8%

65 plus and retired 2.8% 3.1% 3.6% 4.9% 8.8% 11.8% -0.3% 0.8% 3.4% 5.9%

Married 12.7% 13.7% 21% 19% 24% 23.2% 0.2% -2.5% 0.4% 7.1%

Single women 11.8% 12.2% 14.8% 14% 20.4% 26.7% 2.6% -0.2% 2% 9.2% 1

Single men 7.3% 11.6% 18% 14.4% 20.4% 20.1% 0.1% -2.9% -2.4% 9%

Bottom quintile 5.9% 8.6% 11.5% 16.1% 11.4% 17.1% 1.3% 1.7% 2.1% 3.3%

Second quintile 18.3% 15.7% 12.8% 12.7% 24.1% 23.9% -0.4% 1.7% -0.6% 6.9%

Third quintile 14.6% 18.5% 26.6% 22.3% 30.6% 35.5% 3.8% -3.1% 5.1% 9.3% 1

Fourth quintile 14.7% 16.8% 22.5% 18.9% 26.8% 31.3% 1% -4.7% 4.6% 8.7% 1

Fith quintile 8.7% 8% 18.7% 16.1% 18.6% 13.5% -0.7% -2.7% -5.4% 7.5%

Without DB pension 9.1% 11.4% 17.8% 16.5% 21.5% 24.9% 2.4% 0% 2.9% 9.3% 1

With DB pension 16.8% 15.9% 21.3% 18.2% 24.5% 19.4% -1.3% -5.8% -5.4% 5.9%

Notes: All levels are in percent and all changes are in percentage points. Very high risk exposure means that households had below

median wealth to income, more than 75% o their assets in risky assets, and debt greater than 25% o their assets. The sample only includes

households with any assets, who are 50 years old or older, and who are not retired, except or the comparison by retirement status. All demo-graphic characteristics reer to the head o the household. All economic characteristics reer to the entire household.

Very high risk exposure increased slighly boh during and aer he Grea

Recession. Households headed by whie non-Hispanics, single women, hose in

he hird and ourh income quinile, and hose wihou dened-bene pensions

saw heir share o households wih very high risk exposure go up rom 2007 o

2010. Very high risk exposure narrowed by race and ehniciy bu widened by

income during he Grea Recession.

Te risk-exposure gap also widened in key insances over he longer period o1989 o 2010. Te risk exposure or nonwhie households, or example, has grown

aser han he risk exposure or whie amilies. I has also grown aser or younger

households han or households headed by someone 65 years old or older and or

middle-income households han or lower-income or higher-income households.


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Te daa sugges ha risk exposure did no converge beween groups over ime, as

i would have i risk had been managed well.

Very high risk exposure only declined during he bursing o he docom bubble,

remaining relaively sable during boh he savings and loan crisis and he Grea

Recession. Te share o households wih very high risk exposure, or insance,increased slighly rom 11.9 percen in 1989 o 13 percen in 1992, ell rom 18.9

percen in 1998 o 17.3 percen in 2001, and rose again rom 22.6 percen in 2007

o 23.7 percen in 2010. (see able 1) A breakdown by populaion groups dur-

ing hese hree crises shows ha he risk exposure increased or he majoriy o

household groups, alhough here are some or which i ell. Te summary daa

indicae ha sharp sock- and house-price drops were shor lived and asse prices

recovered quickly, ha household ook more risk during crises, or boh. Te daa

do no suppor he noion ha when risk maerialized, crises resuled in down-

ward correcions o risk exposure.

In ac, risk exposure has gone up beween crises, even hough we would have

expeced sable risk exposure since imes were quie enough o allow households

o bes manage heir risk exposure. Te share o households wih very high risk

exposure rose by 5.9 percenage poins rom 1992 o 1998 and by 5.3 percen-

age poins rom 2001 o 2007. (see able 1) Te daa sugges ha household risk

exposure was driven by exernal acors such as sock- and house-price bubbles

and deb booms and ha households did no counerac hese orces during non-

crises imes by, or insance, regularly rebalancing heir porolios.

High leverage and lack of asset diversification contribute

to risk exposure

Bu which acorleverage or risky asse concenraiondrove very high risk

exposure o new highs? able 2 briey summarizes rends in risk exposure by

risky-asse concenraion and oal leverage.

Te summary o very high risk exposure in he previous secion showed hree

key poins abou he share o older nonreiree households wih very high riskexposure. Firs, risk exposure rended up rom 1989 o 2010. Second, i remained

relaively sable during crises. Tird, i grew beween crises.


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able 2 shows ha hese hree acors did no depend on risky-asse concenra-

ion or on leverage alone, bu raher on a combinaion o boh acors.30 Boh

risky-asse concenraion and leverage rended up rom 1989 o 2010; boh

measures were more likely o go up han down during crises; and boh measures

rose beween crises. Te growing risk exposure o older nonreiree households

was hus he resul o wo disinc phenomena: rising risk exposure and increasingleverage. Tis implies ha policy soluions mus address household risk exposure

comprehensively by giving households he nancial-managemen ools o address

boh asse diversicaionor lack hereoand deb.

TABLE 2

Median risky asset concentration and leverage

Variable Measure 1989 1992 1998 2001 2007 2010

1989 to

1992

1998 to

2001

2007 to

2010

19

2

Debt to assets Median 5.4% 6.7% 12.8% 11.6% 16.1% 19.1% 1.3% -1.2% 3% 1

Risky assets tototal assets

Median 60.3% 60.3% 67.5% 68% 69.1% 64.5% 0% 0.5% -4.6%

Notes: All fgures are in percent. Changes are in percentage points. Averages and medians calculated or households 50 years old and older,who are not retired. Debt to income is summarized only or households with any debt. Home equity share out o total house values is alsosummarized only or homeowners. The share o stocks out o fnancial assets is summarized only or households with any stocks. Stocks

include directly and indirectly held stocks. Risky assets are the sum o stocks and residential real estate. Authors calculations based on Boardo Governors, Federal Reserve System. (various years). Survey o Consumer Finances. Washington, DC: BOG.


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Detailed data show that risk

exposure has become excessive

Te ollowing discussion considers again he our conceps relaed o well-man-

aged household risk. Firs, household wealh should have been rending upward

i households had indeed aken advanage o invesmen opporuniies. Second,

here should have been convergence in risk exposure beween groups over ime.

Tird, here should have been a downward correcion in risk exposure during cri-

sesor a leas no an increase in risk exposure. And ourh, risk exposure should

have been relaively sable beween crises, and i should no have increased.

Te discussion relies on he median wealh-o-income raio, he median raio o

deb o asses, and he median share o risky asses ou o oal household asses. 31

Te median is he number ha divides he sample exacly in hal, so ha one hal o

households shows more leverage, or insance, and he oher hal shows less leverage

han he median. Median values capure he ypical households experience.

Wealth-to-income ratios were consistently unstable and fell to

nearly 20-year lows in 2010

Median wealh-o-income raios varied by household characerisics in 2010. (see

able 3) Whies, or example, had a raio ha was hree imes ha o nonwhies,

and non-Hispanics had a raio ha was more han double ha o Hispanics.

Younger households also had a lower raio han older households; nonreirees

had a lower median raio han reirees; single men had a lower raio han single

women; and single women had a lower raio han married couples.

Addiionally, median wealh-o-income raios increased wih income in 2010. (see

able 3) Households wih dened-bene pensions had a subsanially highermedian raio o wealh o income357 percenhan households wihou

dened-bene pensions, which had a median raio o 239.5 percen in 2010. (see

able 3) Communiies o color, lower-income households, single-paren-headed


20/44


households, and households wihou dened-bene pensions enjoyed less eco-

nomic securiy han heir counerpars aer he Grea Recession.

TABLE 3

Wealth to income, by selected demographic characteristics andselected years

Variable 1989 1992 1998 2001 2007 2010

1989 to

1992

1998 to

2001

2007 to

2010

19

2

White 320.6% 380.3% 327.9% 362.9% 412.2% 332.9% 59.7% 35% -79.3% 1

Non-white 148% 121.4% 121.8% 156.2% 203.1% 107.6% -26.6% 34.4% -95.5% -4

Non-Hispanic 281.3% 329% 298.9% 324% 370.5% 286.9% 47.7% 25.1% -83.6% 5

Hispanic 132.5% 96.2% 135.8% 121.2% 169.8% 135.9% -36.3% -14.6% -33.9% 3

50 to 64, not retired 254.7% 279% 261.3% 286.6% 338.3% 239.7% 24.3% 25.3% -98.6% -

65 plus, not retired 368.3% 438.5% 480.5% 488.9% 539.7% 414.4% 70.2% 8.4% -125.3% 4

65 plus and retired 533.6% 558.9% 612.4% 743.7% 774.7% 589.4% 25.3% 131.3% -185.3% 5

Married 305.9% 305.6% 309.4% 340% 381.3% 320.3% -0.3% 30.6% -61% 1

Single women 224.4% 320.2% 254.7% 262.7% 325.2% 180.5% 95.8% 8% -144.7% -4

Single men 185.4% 369.4% 269.4% 236.8% 281.7% 141.6% 184% -32.6% -140.1% -4

Bottom quintile 57.5% 191.3% 65.7% 153.6% 117% 32% 133.8% 87.9% -85% -2

Second quintile 366.6% 319.9% 305.7% 264.5% 281.5% 115.8% -46.7% -41.2% -165.7% -25

Third quintile 294.9% 296.9% 233.5% 260.9% 331.8% 228.7% 2% 27.4% -103.1% -6

Fourth quintile 254.6% 323% 285.8% 332.5% 355.6% 252.1% 68.4% 46.7% -103.5% -2

Fith quintile 348.8% 373.7% 408.5% 447.6% 520.3% 521% 24.9% 39.1% 0.7% 17

Without DB pension 296.8% 320.2% 296.9% 284.1% 366.3% 239.5% 23.4% -12.8% -126.8% -5

With DB pension 246.7% 299.4% 277.4% 337.9% 359.8% 357% 52.7% 60.5% -2.8% 11

Notes: All fgures are in percent. Changes are in percentage points. Averages and medians calculated or households 50 years old and older,

who are not retired. Debt to income is summarized only or households with any debt. Home equity share out o total house values is alsosummarized only or homeowners. The share o stocks out o fnancial assets is summarized only or households with any stocks. Stocksinclude directly and indirectly held stocks. Risky assets are the sum o stocks and residential real estate. Authors calculations based on Board

o Governors, Federal Reserve System. (various years). Survey o Consumer Finances. Washington, DC: BOG.

Wealh-o-income raios dropped sharply during he Grea Recession. Median

raios or key populaion groups in 2010 were lower han in 1989 as a resul o

he large wealh losses ha occurred during he Grea Recession. Tis was rue

or nonwhies, Hispanics, younger households, single-paren-headed households,

households in he botom 60 percen o he income disribuion, and householdswihou dened-bene pensions. (see able 3) In oher words, wealh-o-income

raios were unsable when comparing he wo endpoins o our daa series, 1989

and 2010. In ac, hey wen down.


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Bu median wealh-o-income raios also ucuaed beween 1989 and 2010. Tere

is no single patern ha dominaes he wealh-o-income rends, bu he daa in

able 3 show ha wealh-o-income raios ypically did no ollow a clear upward

rend. ake, or insance, he wealh-o-income raio or whie households. I rose

rom 1989 o 1992, bu i hen ell and did no surpass 1992s high level unil 2007,

nally alling o a level close o ha o 1989 in 2010. Te median wealh-o-incomeraio or households in he hird quinile sayed relaively sable rom 1989 o 2001,

rising o is highes level331.8 percenin 2007 and alling o is lowes level

228.7 percenin 2010. Te daa in able 3 show similar movemens or house-

holds in he ourh income quinile, or single women, and or nonwhies.

Te daa hus sugges ha here is no clear upward rend in wealh-o-income

raios or large shares o he populaion, alhoughor perhaps becausehese

are oen he same populaion groups ha have experienced disproporionaely

large increases in risk exposure, as shown below. Ta is, he daa do no indicae

ha households by and large managed heir risk exposure well enough o akeadvanage o invesmen opporuniies. Te implicaions, hen, are ha changes

in household wealh were he resul o exernal orces more han he resul o per-

sonal nancial decisions and ha household wealh was poorly managed during a

ime o growing exernal nancial risks.

Differences in amount of leverage between groups widened

Wealh-o-income raios did no rend upward over ime, as he previous secion

shows. Te nex quesion ha will help deermine wheher household wealh was

well managed is wheher risk exposure converged beween groups over ime. I

will also help o look a he movemen o risk exposure during and beween crises.

able 4 summarizes he median deb-o-asses raio or household groups rom

1989 o 2010. In 2010 leverage was higher among nonwhies, Hispanics, younger

households, nonreirees, single women, households in he middle income quin-

ile, and households wihou dened-bene pensions han among heir couner-

pars. (see able 4)


22/44


TABLE 4

Debt to assets, by selected demographic characteristics and selected years

Variable 1989 1992 1998 2001 2007 2010

1989 to

1992

1998 to

2001

2007 to

2010

19

2

White 4.3% 5.5% 9.3% 10% 14.8% 17.4% 1.2% 0.7% 2.6% 1

Non-white 9.1% 12.7% 18.4% 21.8% 25.3% 26.4% 3.6% 3.4% 1.1% 1

Non-Hispanic 5.2% 6% 12.3% 11.3% 16.3% 18.8% 0.8% -1% 2.5% 1

Hispanic 9.1% 18.3% 20.8% 26% 14.5% 24.9% 9.2% 5.2% 10.4% 1

50 to 64, not retired 9.1% 12.2% 17.2% 15.1% 19.8% 22.7% 3.1% -2.1% 2.9% 1

65 plus, not retired 0% 0% 0.2% 1.1% 4% 8.2% 0% 0.9% 4.2% 8

65 plus and retired 0% 0% 0% 0% 4% 0% 0% 0% 0%

Married 7.7% 11.5% 15.4% 13.4% 18.1% 19.1% 3.8% -2% 1% 1

Single women 0.4% 0.6% 7.5% 4.8% 14.2% 23.3% 0.2% -2.7% 9.1% 2

Single men 0.5% 3.4% 8.9% 8% 10.2% 14.3% 2.9% -0.9% 4.1% 1

Bottom quintile 0.4% 0% 0% 2.3% 3.5% 10.4% -0.4% 2.3% 6.9% 1

Second quintile 2.7% 3.1% 7.4% 9.8% 16.3% 18.3% 0.4% 2.4% 2% 1

Third quintile 8.3% 12.7% 21.1% 15.7% 24% 32.4% 4.4% -5.4% 8.4% 2

Fourth quintile 7.5% 11.3% 19.5% 14.5% 20.7% 24.2% 3.8% -5% 3.5% 1

Fith quintile 7.9% 12.1% 13.1% 11.3% 14.6% 13.3% 4.2% -1.8% -1.3% 5

Without DB pension 2% 4% 10.7% 9.3% 14.3% 20.3% 2% -1.4% 6% 1

With DB pension 11.7% 14.6% 17.1% 13.4% 19.9% 15.8% 2.9% -3.7% -4.1% 4

Notes: All fgures are in percent. Changes are in percentage points. Averages and medians calculated or households 50 years old and older,who are not retired. Debt to income is summarized only or households with any debt. Home equity share out o total house values is alsosummarized only or homeowners. The share o stocks out o fnancial assets is summarized only or households with any stocks. Stocks

include directly and indirectly held stocks. Risky assets are the sum o stocks and residential real estate. Authors calculations based on Boardo Governors, Federal Reserve System. (various years). Survey o Consumer Finances. Washington, DC: BOG.

Leverage increased or almos all groups during and aer he Grea Recession.

Households in he middle income quinile saw a paricularly large increase o 8.4

percenage poins, rom 24 percen in 2007 o 32.4 percen in 2010. Leverage or

mos oher groups ypically increased by beween 2 percenage poins and 5 per-

cenage poins in hose years. Te excepions were households in he op income

quinile and households wih dened-bene pensions. Leverage ell in boh hese

insances during and aer he Grea Recession, rom 2007 o 2010. (see able 4)

Tese changes highligh largely widening dierences in household leverage rom1989 o 2010. A number o household groups sared ou wih higher leverage

han heir counerpars in 1989 and saw aser increases in leverage rom 1989 o

2010. Tis was rue o nonwhies, Hispanics, younger households, nonreirees,

and middle-income households. Tese groups o households moved urher apar


23/44


rom heir counerpars in erms o leverage rom 1989 o 2010. (see able 4) wo

household groupssingle women and households wihou dened-bene pen-

sionseven overook heir counerpars in erms o leverage: Boh had less lever-

age han heir counerpars in 1989 bu higher leverage in 2010. Ta is, he daa

do no suppor he noion o convergence in risk exposure, which, had i been he

case, ypically would have mean ha households were managing heir risk well.

Leverage was more likely o rise during crises han o all. Leverage almos univer-

sally increased during boh he savings and loan crisis and he Grea Recession.

Bu he record was a litle more mixed during he bursing o he docom bub-

blesome groups saw increasing leverage, while ohers saw i all. (see able 4)

Te overarching rend, however, was increasing leverage during crises, a sign ha

risk was no managed well.

Te deb-o-asses raio or mos households also increased sharply beween crises,

rom boh 1992 o 1998 and 2001 o 2007. Tis is surprising because hose periodswere also periods o raher srong asse gains due o sock- and house-price booms.

Leverage likely rose beween crises because households saved less han in he pas as

a resul o he wealh eec during he period rom 1992 o 1998. And households

may have borrowed a a aser rae han hey buil asses due o a mix o rising prices

or housing, educaion, healh care, and slow income growh in he period rom

2001 o 2007.32 Well-managed risk, however, would have mean sabiliy in erms o

leverage beween crises, and cerainly no an increase.

Risky-asset concentration follows price movements

able 5 shows he daa on households concenraion o risky asses. Well-

managed asses should again be indicaed as convergen risk exposure beween

groups, decreasing risk exposure during crises, and comparaively sable risk

exposure beween crises.

Tere were ew dierences in risky-asse concenraion in 2010 by race, ehniciy,

dened-bene pension coverage, prereirees beween he ages o 50 and 64, and

reirees aged 65 years and older. (see able 5) Tese groups had a median share oabou wo-hirds o heir asses allocaed in socks and housing.


24/44


TABLE 5

Measures of risky asset concentration, by selected demographic

characteristics and selected years

Variable 1989 1992 1998 2001 2007 20101989 to

1992

1998 to

2001

2007 to

2010

19

2

White 57.7% 57.9% 67.5% 68.1% 67.8% 64.2% 0.2% 0.6% -3.6% 6

Non-white 74.2% 74.9% 65.7% 67.8% 77.3% 64.9% 0.7% 2.1% -12.4% -9

Non-Hispanic 60.3% 59.3% 67.1% 68% 68.8% 64.5% -1.0% 0.9% -4.3% 4

Hispanic 59.1% 96% 81.1% 71.0% 80.7% 65.6% 36.9% -10.1% -15.1% 6

50 to 64, not retired 62.6% 60.6% 67.9% 69.4% 70.2% 65.2% -2.0% 1.5% -5.0% 2

65 plus, not retired 52.9% 63.9% 66.4% 59.2% 59.7% 61.6% 11% -7.2% 1.9% 8

65 plus and retired 53.2% 61.1% 59.4% 70.6% 70.3% 66.7% 7.9% 11.2% -3.6% 1

Married 63.2% 58% 67.6% 68.8% 69.2% 63.6% -5.2% 1.2% -5.6% 0

Single women 61% 65.8% 67.4% 64.6% 71.4% 71.3% 4.8% -2.8% -0.1% 1

Single men 41.8% 57.5% 68% 72.2% 62.6% 56.0% 15.7% 4.2% -6.6% 1

Bottom quintile 55.2% 79.9% 76.8% 73.5% 45.9% 46.7% 24.7% -3.3% 0.8% -8

Second quintile 77.3% 67% 54.6% 64.5% 75.5% 65.2% -10.3% 9.9% -10.3% -1

Third quintile 58.2% 69% 72.4% 70.1% 72.1% 74.3% 10.8% -2.3% 2.2% 1

Fourth quintile 60.5% 64.2% 68.5% 67.7% 70.8% 73.8% 3.7% -0.8% 3% 1

Fith quintile 52% 51.2% 64.9% 66.6% 64.3% 56.2% -0.8% 1.7% -8.1% 4

Without DB pension 53.2% 59.4% 66.4% 63.1% 65.2% 64.6% 6.2% -3.3% -0.6% 1

With DB pension 68.1% 60.8% 68.6% 72.2% 72.8% 63.2% -7.3% 3.6% -9.6% -4

Notes: All fgures are in percent. Changes are in percentage points. Averages and medians calculated or households 50 years old and older,who are not retired. Debt to income is summarized only or households with any debt. Home equity share out o total house values is also

summarized only or homeowners. The share o stocks out o fnancial assets is summarized only or households with any stocks. Stocksinclude directly and indirectly held stocks. Risky assets are the sum o stocks and residential real estate. Authors calculations based on Board

o Governors, Federal Reserve System. (various years). Survey o Consumer Finances. Washington, DC: BOG.

Te risky-asse allocaion by oher characerisics, however, varies subsanially.

Households in he hird income quinile had 74.3 percen o heir oal asses in

risky asses, compared o only 46.7 percen or households in he botom income

quinile and 56.2 percen or households in he op income quinile. And single

women held more han 70 percen o heir oal asses in risky asses in 2010,

compared o only 56 percen o single men.

Tere is no clear rend oward convergence in risky-asse allocaion across house-hold groups rom 1989 hrough 2007 and beore he Grea Recession, when risky-

asse allocaions reversed. Hispanics and non-Hispanics, or insance, had roughly

he same risky-asse allocaion in 1989, bu he risky-asse allocaion o Hispanics

grew much aser han ha o non-Hispanics hrough 2007, in large par because


25/44


Hispanics held more o heir risky asses in housing han did non-Hispanics.

Tere was also a widening gap by age rom 1989 o 2007 and a roughly seady gap

beween single women and married couples during he same ime period.

Te concenraion o household asses in socks and housing declined or

almos all groups rom 2007 o 2010. Te larges decreases came or nonwhies,Hispanics, younger households, reirees, single women, households in he op

income quinilewhich was closely ollowed by households in he second

income quinileand households wih dened-bene pension coverage. Te

larger losses in he share o risky asses or hese groups han or heir counerpars

ypically reec a higher concenraion in risky asses in 2007.

Te share o socks and houses ou o oal asses in 2010 was ypically a is low-

es level since a leas 1992.33 Ta is, households eiher may have had oo much

risk exposure buil up in he years prior o he crisis or less han heir desired risk

exposure in 2010. Te sharp reversal in risky-asse concenraions during and aerhe Grea Recession, hereore, may have no reeced desired asse-allocaion

changes by households, insead reecing sharp price declines ha were no coun-

ered by acive porolio rebalancing.

able 5 shows a mixed record o changes in risky-asse concenraion during

crises. I ypically rose during he savings and loan crisis; i rose or some groups

and ell or ohers during he bursing o he docom bubble; and i declined

widely during he Grea Recession. Tere is some evidence ha large-asse price

declinesa reecion o nancial risks maerializingled o a correcion in

households risk exposure alongside large wealh losses, as discussed above.

Te acs ha wealh did no grow, ha households los increasingly large shares o

heir wealh during crises, and ha risky-asse concenraion dropped increasingly

during crises alongside he wealh losses indicaes ha households buil up more

risk exposure beween crises. Indeed, able 5 shows subsanial jumps in risky-

asse concenraion rom 1992 o 1998 and rom 2001 o 2007.

Bu here are some key dierences in he iming o he jumps by populaion

characerisics. Whies, non-Hispanics, and single men, or insance, saw largeincreases in heir risky-asse concenraion rom 1992 o 1998, wih litle change

hereaer hrough 2007. Nonwhies, Hispanics, and single women, meanwhile,

acually saw alling asse-concenraion raios hrough 2001 beore hey increased

again hrough 2007. Addiional daa no explored here show ha hese dier-


26/44


ences did no resul rom a greaer emphasis on socks by whies, non-Hispanics,

and single men han by nonwhies, Hispanics, and single women. During he

earlier period hrough 1998, he share o socks ou o nonhousing nancial asses

increased, saying a hrough 2007 or all groups, regardless o race or ehniciy.

Ta is, he dieren build-up paterns in risky-asse concenraionearlier or

some groups han or ohersare likely a conuence o oher acors.34

Te above daa discussion shows ha household risk has no been managed well

in he pas and ha risk exposure has hence become excessive or many near-

reiree households.


27/44


Conclusion and policy implications

Households can ace subsanial nancial risk exposure due o heir level o

debleverageand a high concenraion o asses in risky invesmens. Ta

is, when prices or socks and houses move up or down, oal household asses

can also experience subsanial ucuaionsin exreme cases, even augmened

ucuaions can occur.

Households can gain and lose massive amouns o wealh in risky nancial mar-

kes. Tis volailiy can come rom large asse-price movemens, he likes o whichoccur during sock- and housing-marke bubbles. I can also happen when house-

holds are exposed o hose price ucuaions hrough leverage and hrough having

a large concenraion o risky asses as a share o heir oal asses.

Boh price ucuaions and risk exposure are par o saving and invesing in

nancial markes. Te issue, hough, is wheher households ace excessive risks

and hus save oo litle or key lie evens such as reiremen. Policymakers have

sared o pu policies in place o poenially lower he risks o large-asse price

bubbleshrough, or example, increased capial requiremens or banks, which

would mean ha banks would become more careul in speculaing because

hey would have more o heir own money a sake, and he Financial Sabiliy

Oversigh Council, which is asked wih ideniying emerging risks ha can

hreaen he healh o he enire U.S. economy and hus hopeully lead policy-

makers o inervene earlier in poenially dangerous siuaions han hey did

beore he Grea Recession. Bu here have been ew eors o acually address

households risk exposure.

Te summary o household-level daa presened in his paper shows ha house-

holds have ypically no managed heir risk exposure well. In oher words, house-holds did no gain as much wealh as hey could have i hey had beter managed

heir risk exposure. Te daa, or insance, show ha wealh ucuaed and did no

rend upward as households ook on more risks in search o greaer rewards. Tere

was also no convergence in risk exposure beween households, no sysemaic


28/44


downward correcion o risk exposure during crises, and oo much risk exposure

buil up beween crises, when imes were less urbulen and households could

have beter managed heir risk exposure. Te daa do sugges ha boh leverage

and risky-asse concenraion play a role in household risk exposure, alhough

leverage appears o be he more widespread and more consisenly poorly man-

aged risk acor.

Policy implications

Te discussion in his repor highlighs he need or greaer policy emphasis on

helping households manage heir risks. Such an approach should be as com-

prehensive as possible. Households los wealh during he Grea Recession, or

insance, boh because hey were heavily invesed in risky asses and because hey

were comparaively highly leveraged due o a housing and morgage boom beore

he crisis. Policy responses ha are argeed a helping households beter manageheir nonhousing asses separaely rom heir housing asses may miss a large par

o households risk exposure and heir need o manage nancial risks. Pracically

speaking, his means ha policy eors should ocus on making morgages as

aordable and as sae as possible, and ha eors inended o increase homeown-

ership should be coupled wih eors o increase savings ouside o he home so

ha households have a buer o all back on when house prices dip or income

oherwise diminishes.

Broadly speaking, households have wo venues in which o manage heir risk

exposure. Purchasing insurance is one such venue, and beter risk managemen

is he oher. Policymakers can consider possible seps o give households beter

access o aordable and appropriae insurance and beter risk-managemen ools.

Households could purchase insurance o secure some o heir nancial asses.

Tese insurance-ype producs include nancial derivaives such as uures,

opions, and swaps, which oer invesors a promise o uure asse prices and hus

some assurance agains losses. Insurance producs also include rae-o-reurn guar-

anees oered by insurance companies or muual unds, hrough which invesors

are assured ha heir asses will no perorm worse han a predeermined averagerae o reurn over long periods o ime such as one or wo decades.

Insurance producs, however, are burdened by a number o problems ha make

hem less han ideal as universal ools. Firs, hey carry a ee, especially or middle-


29/44


income and lower-income households. Second, insurance markes may be limied,

and hey may only be available or households ha already have subsanial

assesalhough policymakers can help grow markes hrough nancial incen-

ives. Tird, any insurance produc is only as good as he insurance company

ha oers i. As he Grea Recession has shown, however, insurance companies

can ail i he insured incidenceasse lossesoccurs on a large enough scale.Policymakers can help srenghen he insurance marke, bu some chance ha

insurance companies will ail will sill remain.

Te botom line is ha households may experience pracically uninsurable risk

exposure. Tey can alernaively engage in nancial sraegies o manage heir

risk exposure by couneracing he poenial hrea o more leverage and a greaer

risky-asse concenraion han hey wan. Tey can reduce heir leverage by saving

more, especially by invesing in asses ha are no direcly linked o heir deb. So

hey could save in nonhousing asses i mos o heir deb is in he orm o a mor-

gage. And hey can diversiy heir asses away rom risky asses, especially aerrisky-asse prices have increased.

Tese sraegies are bes explained wih an example. A household may owe

$80,000 on a $100,000 home, or insance, and own no oher major asses. Tis

household has a deb-o-asse raio o 80 percen and a risky-asse concenraion

o 100 percen since all o is asses are in he orm o is home, which is consid-

ered a risky asse. Te same household can lower is leverage and risky-asse con-

cenraion by saving money ouside o he homeputing, or example, $10,000

ino a 401(k) savings accoun. Is deb-o-asse raio hen alls rom 80 percen

o 72.3 percen$80,000 divided by $110,000and he risky-asse concenra-

ion decreases o 91 percen$100,000 divided by $110,000assuming ha all

o he money in he households 401(k) accoun is invesed in asses oher han

socks. Had he household insead used he exra $10,000 o pay o he morgage

aser, lowering is deb rom $80,000 o $70,000, is deb-o-asse raio would

have dropped o 70 percen insead o 72.3 percen, bu is risky-asse concenra-

ion would have remained a 100 percen since all o is asses would sill be in is

house. By saving more and diversiying is assesinvesing in somehing oher

han a house and sockshe household lowers is risk exposure hrough less

leverage and a lower risky-asse concenraion.

Households ha are in deb oen do no have sufcien income o save a lo o

exra money and quickly reduce heir leverage. Tey could insead reduce heir

leverage over ime by renancing heir deb ino deb wih a lower ineres rae.


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Tis may include, or example, aking ou a home equiy line o pay o a higher-

ineres credi card and payday loandepending on he ineres raes on each loan

and he households ax siuaion. Households could use he savings rom lower

ineres paymens o inves in oher less-risky asses such as savings accouns.35

Households could also use exising invesmen producs o help hem manageheir risk exposure wih nancial asses.36 Households can inves par or all o

heir asses in so-called arge-dae unds or model porolios.37 Tese muual

unds combine socks and oher nancial asses a a risky-asse raio desired by

he invesors60 percen invesed in socks, or example, and 40 percen in

bonds. Te und managers will make sure ha he model porolio mainains he

desired risky-asse allocaion on a regular basis, so ha he risky-asse allocaion

can never ge oo ar away rom he original level o 60 percen. Tese unds oen

also reduce he risky-asse allocaionhe share o socks in he porolioas

households ge older and closer o reiremen and ypically wan less risk expo-

sure. In he above example, he allocaion o socks drops rom 60 percen as hehousehold nears reiremen o beter ensure ha he household will have enough

savings upon reiremen.38

Anoher sep would be o ake advanage o proessional risk-managemen sraegies.

Households wih higher incomes and more wealh end o be much more likely o

rely on proessional advice rom regulaed individuals such as accounans and law-

yers. Relying on such advice may allow or a more comprehensive risk-managemen

sraegy han a do-i-yoursel approach. Policymakers could suppor such eors

by oering ax credis or qualied regulaed proessional advice.39

Households will nd i easier o use available risk-managemen sraegies in he

righ policy environmen. Policymakers can aciliae risk managemen hrough

greaer ransparency o risk exposure, auomaing desired invesmen choices

hrough deaul invesmen opions, and helping develop key markes such as

hose or insurance and reinsurance producs and hose or proessional advice.

Policies ha will help households beter manage heir risk exposure will auomai-

cally increase uure income securiy since he available asses will las longer.

Comprehensively managing household nancial risk exposure should hus be an

inegral par o all asse-building policies.


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About the author

Christian E. Weller is a Senior Fellow a he Cener or American Progress and

a proessor o public policy a he McCormack Graduae School o Policy and

Global Sudies a he Universiy o Massachusets, Boson. His areas o exper-

ise include reiremen income securiy, macroeconomics, money and bank-ing, and inernaional nance. He is also a research scholar a he Universiy o

Massachusets, Amhers, Poliical Economy Research Insiue and an insiue

ellow a he Universiy o Massachusets, Boson, Geronology Insiue. Prior o

joining CAP, he was on he research sa a he Economic Policy Insiue, where

he remains a research associae.


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Appendix A: Review of the relevant literature on wealth and

risk exposure

In his repor, household risk reers o he uncerainy o uure income, especially

or reiremen, in boh upward and downward direcions. Tis uncerainy resuls

rom household-wealh risk exposure since i can ucuae up and down more ihere is more risk exposure.

Individual risk exposure

Te composiion o wealh has changed over he pas decades, resuling in greaer

individual risk exposure. Tis added risk is ypically no ully accouned or in

calculaions o reiremen wealh.

Wealh is he dierence beween asses and deb. Asses include personal sav-ings such as owner-occupied homes and nancial asses, uure dened-bene

pension benes, and Social Securiy benes. Deb includes morgages and oher

money owed.

Privae savings direcly expose households o a number o nancial risks, includ-

ing marke and invesmen risks.40 Marke risk exposure ollows rom large price

swings or socks and houses41 because o he iming o purchases and sales42

and because savings decisions can change.43 Invesmen risks exis because com-

plex invesmen decisions open he possibiliy or subopimal oucomes based

on marke ucuaions.44

Only limied risk proecions are available. Workers can proec hemselves rom

invesmen risk by conribuing regularly o savings accouns and sably diversiy-

ing heir asses. Opimizaion o conribuions and invesmens, however, is oen

hindered by psychological obsacles such as he inabiliy o ully process complex

inormaion, he inabiliy o sick o a nancial plan, saus-quo bias in nancial deci-

sionsno waning o change he way hings are currenly even i hey aren working

welland herd behaviormaking decisions based on wha a larger group o peers

is doingall o which leads o oo litle savings and oo much risk.45

Tere also isnhe same proecion agains marke risk in privae savings as here is in Social Securiy

and dened-bene pensions. Individual savings accouns have nie horizons, while

dened-bene plans, or insance, have longer ime horizons ha allow hem o

smooh ou he losses susained in a shorer ime period wih gains in anoher.46


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Te lack o risk proecions poses a growing problem since he share o privae-

secor workers wih a dened-bene pension has declined and he share o

workers wih a dened-conribuion plan has risen since he early 1980s.47

Reiremen-wealh sudies oen eliminae marke, invesmen, and longeviy risk

exposure by assuming ha reirees will ollow a uniorm savings rae and make

balanced invesmen choices, by assuming ha asse markes will produce a sablerae o reurn, and by assuming ha households will annuiize heir wealh.48 More

risk exposure means ha he same amoun o wealh can buy less income securiy.

The economic logic of r ising individual risk exposure

As discussed in his repor, he rends over he pas hree decades show a grow-

ing household risk exposure. Policymakers inended or his greaer explici risk

exposure o happen: Te original economic logic was ha more risk poses a cos

o individuals, who generally do no like risk. Individuals would consequenly savemore o compensae or he greaer risk exposure.49

More recen research done in he eld o behavioral economics has shown ha

his logic has is limis since i makes unrealisic behavioral assumpions abou

individual decisions.50 Te radiional economic logic assumes ha individuals

ully undersand complex risks, compleely undersand how o proec hemselves

rom hese risks, and will ac upon his knowledge. Bu humans generally do no

have he ull appreciaion o all o he complexiies o heir nancial decisions, and

even when hey do, hey do no necessarily ac on ha knowledge. I hus seems

ha greaer risk exposure has resuled in more savingsbu no enough o ully

compensae or he increase in individual risk exposure over ime.51


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Appendix B: High wealth went along with high insecurity before

the crisis

Household wealh increased over ime, bu his growh wen along wih rising

demands on personal wealh as households became increasingly responsible or

saving or heir own reiremen, healh care, rising housing coss, heir childrenseducaion, and oher demands.

Increasing demands on household wealh, in ac, mean ha more average wealh

wen along wih growing economic insecuriy during he 2000s. Te share o

amilies ha are prepared or medical or economic emergencies, or insance, has

allen since 2000.52 Only an esimaed 33.9 percen o amilies had sufcien sav-

ings o cover a medical emergency in 2007, down rom 43.7 percen in 2000. And

he share o amilies ha had enough wealh o cover an economic emergency

equal o hree monhs o heir incomeell o an esimaed 29.4 percen in 2007,

down rom 39.4 percen in 2000.53 Economic insecuriy rose even beore heGrea Recession and during a ime o growing average wealh.54 Te increases in

economic insecuriy reec rising demands on household wealhespecially or

medical careand increasing wealh inequaliy, which leave a growing number o

households economically vulnerable.55

Tis so-called wealh-insecuriy paradoxhigh wealh and low securiyis also

apparen in aggregae economic disress measures ha grew alongside rising aver-

age wealh. Bankrupcy raes, or insance, increased hrough 2005 and rose again

aer dropping in he wake o a new bankrupcy law ha wen ino eec in he

all o 2005 and made i harder or households o ge a resh sar in bankrupcy

cour.56 Similarly, ollowing he recession ha ended in November 2001, he share

o morgages in oreclosure rose o a peak o 1.5 percen in March 2002 beore

dropping o 1 percen in June 2006 and rising again o 2 percen in December

2007, beore he sar o he Grea Recession. Since 1979 he oreclosure rae had

never exceeded 1.2 percen beore he recession in 2001.57 Especially during he

2000s, Households experienced increasing economic disress despie he ac ha

wealh on average oupaced aer-ax income beween 2000 and 2007.

Rising household risk exposure and increasing demands on household savingscan explain he wealh-insecuriy paradox. Te botom line is ha he increases

in wealh have no been enough o compensae or he higher risk exposure o

personal wealh and he increasing demands on personal wealh rom house-

holds growing needs.


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Appendix C: Indicators of individual risk exposure

Household-wealh risk exposure has grown because o more deb, more inves-

mens in risky asses, or a combinaion o he wo. Te daa summaries below

hereore repor wealh-o-income raios and several risk-exposure measures,

specically hose on household leverage and he concenraion o risky asses.

Household leverage or household debt

Leverage ranslaes ino risk exposure because gains and losses o asses are magni-

ed when asse prices go up or down. Tis is bes shown wih a simple example,

also used above. ake a household ha buys a home valued a $100,000 wih

a down paymen o $10,000 and a morgage o $90,000. Te household now

has equiy equal o $10,000 in is homehis is he households wealh. Now

assume ha he homes value alls by 10 percen. Te price o he home drops o$90,000, bu he home equiy ges wiped oua loss o 100 percensince he

household sill owes a morgage o $90,000. Te loss o he household is 10 imes

larger100 percenhan he price decline o 10 percen because he assehe

homeell in value, bu he ousanding deb sayed he same. Te more highly

leveraged a householdhe larger he raio o is deb o is asseshe greaer

he risk o losing subsanial shares o wealh rom comparaively smaller-asse

price drops. Tis is also rue when asse prices go up and more leverage ranslaes

ino greaer gains. Tis repor hus uses he raio o oal deb o asses as one indi-

caor o leverage, whereby a larger raio o deb o asses indicaes more leverage

and hence more vulnerabiliy o drops in asse values.

Diversification of assetsor lack thereofas measured by the

concentration of risky assets

Te concenraion o household wealh in risky asses is he opposie o diversi-

ed asses. Diversied asses are hose ha are spread ou across many dieren

caegories. Diversicaion oers some proecion or household wealh agains

large price swings. Consider a simple illusraive example o wo separae house-holds wih wo dieren asse allocaions. Boh households iniially have $100,000

in asses, bu one allocaes 80 percenor $80,000in socks and he oher pus

only 40 percenor $40,000in socks. Te res o boh households money is

invesed in governmen bonds. A drop in he sock marke o 20 percen resuls


36/44


in a loss o $16,000 o he rs household bu a loss o only $8,000 o he second

household. Spreading ou asses across several caegoriesdiversiying asses

reduces he chance ha loss in one marke ranslaes ino massive wealh declines.

Households oen end up wih comparaively high concenraions o risky asses

because hey did no sell hose asses when he prices increasedno becausehey desired o expose hemselves o a lo o risk. Te allocaion o household

asses o risky asses ollowed he boom and bus cycles in he sock and housing

markes, suggesing ha households oen had more risk exposure han hey had

planned because risky asses such as socks and houses experienced a boom and

hereore ook up a larger par o household porolios.

Consider his example o he eec o rapidly rising risky-asse prices. A household

may have $100,000 invesed in socks and bonds a he beginning o a ve-year

periodhe middle o 2002, or exampleand decide o pu hal o is money in

socks and hal o is money in bonds. Te sock porolio grows each year by 13percen or ve years hrough he middle o 2007. Bonds, on he oher hand, grow

by only 5 percen annually. Tis hypoheical household would have had a raio o

socks o bonds o 59.1 percen aer ve yearsraher han he iniially inended

50 percenbecause he sock marke grew more quickly han anicipaed. Tis

hypoheical household became more exposed o a poenial drop in sock prices

han i had iniially inended.58

Households inves in a range o boh risky and nonrisky asses.59 Tis repor

ollows common nomenclaure and denes socks and houses as risky asses. I

calculaes he share o all risky assessocks plus housesou o oal asses as

one measure o diversicaion. Larger values reec greaer concenraions o risky

asses and hereore increased vulnerabiliies o declines in he marke.

Housing as a risky asset

Economiss usually consider housing a risky nancial asse akin o socks.

Households have equiy sakes in boh kinds o asses ha allow hem o bene

rom he price appreciaion o a house or a sock and rom he income earned on heequiyspecically, saved ren minus morgage paymens and depreciaion in he

case o a house and corporae income minus coss and axes in he case o socks.


37/44


Boh houses and socks come wih subsanial risksnamely he risks o a all in

value and less income han expeced. House and sock prices depend on demo-

graphic changes, changing preerences, and rising unemploymen; prices will all

when demand weakens along wih hese hree acors. Less demand or housing

means lower rens and hus less income due o oregone ren o he homeowner,

and less demand or socks ranslaes ino lower sales, less income, and ewer divi-dends or sock owners.

Housing prices are less volaile han sock prices, bu owning a house comes wih

is own risks ha ose he somewha lower price ucuaions. Firs, households

may need o sell heir home in is enirey a a specic ime o move ino a resi-

dence ha is more appropriae or heir changing needs. Unlike wih a sock por-

olio, households ypically canno sell bis and pieces o heir home. A household

may hus be orced o sell is larges asse in is enirey when prices are down.60

Tis is a iming risk ha is subsanially larger or home han or socks since

socks oen come in much smaller denominaionsespecially when hey areindirecly held hrough muual unds. Te sale o a sock porolio can hereore

occur gradually in order o avoid massive losses.

Second, households may need o borrow agains he equiy in heir homes o pay

or nonhousing consumpion, especially healh care and long-erm care. Credi-

marke consrains due o an overall economic weakness, alling home prices, and

incomplee markesor reverse morgages, or examplemay orce households

o eiher cu heir consumpion or sell heir homes a a loss.61

Tird, housing asses are very illiquid, making i difcul or homeowners o diver-

siy heir asses when housing prices increase.62 Households are consequenly ied

o he ups and downs o he housing marke wihou he opporuniies usually

available wih nancial asses o diversiy ou o an asse when is price increases

and diversiy ino an asse when is price alls.

Fourh, he illiquidiy o housing asses is urher exacerbaed by he ac ha

homeowners end o be leveraged and hus have o inves in heir homes by paying

back he principal on heir morgage. All households ha are somewha nancially

consrained will consequenly see heir exposure o housing-marke risk increasebecause hey canno build sufcien asses ouside o heir home o ose he ris-

ing exposure o heir oal asses o housing-marke risk.63


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Fih, he illiquidiy o housing asses is made even worse by he ineracion

beween housing and labor markes a he regional level. House-price swings

are oen regionally concenraed and no a naional phenomenon, bu regional

house-price swings are highly correlaed wih labor-marke condiions; house

prices all, or example, when unemploymen raes increase. Tis correlaion

urher reduces he liquidiy o housing asses since he pool o poenial buyers inhe local labor marke alls when unemploymen goes up and when house prices

consequenly all. Te correlaion beween housing and labor markes makes

housing a risky asse since house prices experience procyclical swings, which

occur, or example, when he housing marke goes up as unemploymen alls or

he housing marke crashes as unemploymen rises.64

Houses are comparaively risky asses or individual homeowners a any poin

o invesmen. House prices end o be more volaile han bonds, while he rae

o reurn earned on housing asses does no ully compensae or he greaer risk

as compared o bonds.65 Homes are risky asses due o heir geographic specic-iy. Mos households will hereore be exposed o subsanial risks and uncerain

uure income rom heir housing asses.


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Appendix D: Rising risk exposure over time and changing risk

exposure during crises

Risk exposure maters mos when risk maerializes since households sand o

lose subsanial amouns o heir wealh. Economic risks ypically maerialize or

a large number o households during nancial crises66

when, or example, hesock and housing markes plunge. Tis repor ocuses on household wealh and

risk exposure beore and aer hree economic and nancial crises ha occurred

beween 1989 and 2010. (see able A-1) Households ha have a lo o risk expo-

sure a he sar o a crisis will experience more economic damage in a crisis han

households ha have less risk exposure. Teir wealh should decline urher han

is he case or households ha have less risk exposure.

Te hree crises include he savings and loan crisis o he lae 1980s coupled wih he

recession o 1990 and 1991; he bursing o he docom bubble and he subsequen

bear marke on Wall Sree rom early 2000 o lae 2001 combined wih he reces-sion in 2001; and he end o he housing boom ha sared in 2006 combined wih

he Grea Recession, which began in 2007 and ended in 2009. Te discussion o he

aggregae macroeconomic daa will use he acual sar and end daes o he crises

deailed in able A-1. Bu he discussion o riennial household daa rom he Federal

Reserves Survey of Consumer Finances will compare daa rom 1992 wih daa rom

1989, daa rom 2001 wih daa rom 1998, and daa rom 2010 wih daa rom 2007.

TABLE A-1

Description of recent crises

Recession and S&L crisis

Recession and IT bubble

bursting

Great Recession and housing

and mortgage crisis

Recession datesThird quarter 1990 to frst

quarter 1991

First quarter 2001 to ourth

quarter 2001

Fourth quarter 2007 to second

quarter 2009

Change o unemployment

rate during recessionrom 5.7% to 6.8% rom 4.2% to 5.5% rom 4.8% to 9.3%

Dates o wealth lossesFourth quarter 1989 to third

quarter 1990

First quarter 2000 to third

quarter 2001

Second quarter o 2007 to frst

quarter o 2009

Change in real household

wealth (in percent)-4.4% -9.9% -27%

Change in real fnancial, non-

housing wealth (in percent) -5.5% -18% -24.8%

Change in real housing

wealth (in percent)-3.8% 20.6% -48.5%

Notes: All fgures are in percent. Unemployment data taken rom Bureau o Labor Statistics. (2011). Current Population Survey. Washington,

DC: BLS. Authors calculations on wealth data are based on Board o Governors, Federal Reserve System. (2011). Release Z.1 Flow o FundsAccounts o the United States. Washington, DC: BOG. Business cycle dates are rom the National Bureau o Economic Research. (2011).Business Cycle Dates. Cambridge, MA: NBER.


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Te hree crises have several aspecs in common. All o hem included a nancial

crisis in which households susained subsanial wealh losses, ranging rom an

inaion-adjused decline o 4.4 percen in he savings and loan crisis o a decline

o 27 percen in he housing crisis. All hree crises also included a recession wih

unemploymen-rae gains ranging rom 1.1 percenage poins in he early 2000s o

4.5 percenage poins during he Grea Recession. (see able A-1)

Te hree crises occurred agains he backdrop o several major rends. Firs,

American households have borrowed ever-increasing amouns o money, espe-

cially aer he crisis in he early 2000s. Second, he U.S. sock marke experienced

an unprecedened sock marke run up rom 1983 o 2000 and a srong recovery

rom 2001 o 2007, aer he burs o he docom bubble in 2001. Tird, he U.S.

housing marke gained seam in he mid-1990s, wih home prices ev

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