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Unit 8 Economic dynamics: Financial and environmental crises

8.8 Application: Inequality and the US housing boom and bust

So far, we have not considered the role of inequality as a causal factor in the US housing boom and bust. In this section, we set out reasons why the much greater role of housing in the wealth of lower income households meant that while they benefited from capital gains as house prices increased in the upswing, they bore the brunt of the crash.

Figure 8.18 shows trends for the US economy in house prices and in household borrowing, measured as the ratio of household debt to household disposable income. The pace at which house prices were increasing in the US accelerated from the year 2000 and the housing bubble was correlated with a credit boom. This is why it is referred to as a credit-fuelled house price boom.

The line chart illustrates the debt-to-income ratio and house prices in the US from 1950 to 2022. The horizontal axis displays the years from 1950 to 2025, and the vertical axis displays values ranging from 0 to 200. There are two lines: one indicating the household debt-to-income ratio and the other indicating the house price index, with 2005 as the base year set to 100. The line representing the household debt-to-income ratio shows a generally steady increasing trend, rising from nearly 40 in 1950 to 100 in 2000. It then accelerates, reaching a peak in 2006 before decreasing to just above 100 by the end of 2019. After 2019, it starts to soar, exceeding 120 by 2022. The line representing the house price index shows a more rapid increasing trend compared to the household debt-to-income ratio. It rises from 20 in 1975 to a peak of over 120 in 2006. It then decreases to 100 by the early 2010s, before soaring to almost 200 by 2022.
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Figure 8.18 The household debt-to-income ratio and house prices in the US (1950–2022).

US Federal Reserve. 2024. ‘Financial Accounts of the United States, Historical’; U.S. Bureau of Economic Analysis; Federal Reserve Bank of St Louis (FRED).

The collapse followed. The debt-to-income ratio shrank as households saved to restore their target wealth.

Household wealth and inequality

Figure 8.19 provides a snapshot of the composition of household balance sheets when house prices were close to their peak just before the price collapse and financial crisis occurred. The chart distinguishes between home equity, debt, and financial assets. Home equity is how much of your house you own. If you don’t have a mortgage then you don’t owe anything on it (that is, you have no housing debt). You own the house outright and the entire value of the house is your home equity.

In this chart, financial assets include bank account and money market deposits, government and corporate bonds, shares, and other business interests owned by households. Household wealth—or, equivalently, net worth—is financial assets plus non-financial assets (mainly housing) minus any debt. Debt will include student loans, car loans and so on, as well as housing debt.

In the chart, a household’s balance sheet is depicted in a novel way. Usually the assets are in the left column of the balance sheet table and are, by definition, equal to its liabilities plus net worth in the right column. Here the key information is condensed into just one column to facilitate comparisons across different types of households: 100% represents the value of a household’s assets (comprising the value of its non-financial assets plus its financial assets). Another way of expressing this is shown in the figure: its total assets (normalized to 100%) are equal to its total liabilities plus its net worth (which is split between home equity and financial assets).

This bar chart illustrates the wealth and debt of the poorest and richest groups in the US by net worth in 2007. The vertical axis displays households’ net worth plus debt as a percentage of total assets, ranging from 0% to 100%. There are two bars: the first bar represents the net worth plus debt of the poorest 20% of households by net worth, and the second represents the richest 20%. For the poorest group, their net worth constitutes less than 25% of their total assets, with over 75% being debt. Their net worth is composed of home equity and financial assets, with financial assets being only one fifth of the home equity. For the richest group, their net worth constitutes about 90% of their total assets, with debt making up only 10%. Their net worth is also composed of home equity and financial assets, with financial assets being approximately four times the home equity.
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Figure 8.19 Household wealth and debt in the US: poorest and richest quintile groups by net worth in 2007.

Adapted from Figure 2.1 in Atif Mian and Amir Sufi. 2014. House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It From Happening Again. Chicago: The University of Chicago Press.

The left-hand bar shows the data for the poorest 20% of households by net worth. Poorer households are normally only able to borrow if they can use their house as security (collateral) for the loan. They have little financial wealth, as shown by the height of the green rectangle. On average, these households have much more debt than the equity they have in their houses (that is, the mortgage company or bank owns the lion’s share of the house), and are vulnerable to a fall in house prices.

By definition, rich households have a lot of assets (indicated by ‘net worth’ in the figure) relative to their debts. Unlike poor households, their assets mainly consist of financial assets (along with their direct ownership of small businesses, for example).

As background to the credit-fuelled boom that preceded the financial crisis, it is revealing to compare how income and wealth for poorer and richer households evolved over the last 70 years. Using an index set to 100 in 1971, the top panel of Figure 8.20 compares the growth of the incomes of the three groups thereafter. The incomes of the poorest 50% doubled between 1950 and 1971, but grew little thereafter. As incomes of the poorer half stagnated, those of the richest 10% grew to 2.5 times the 1971 level by the time of the financial crisis.

One consequence of the flatlining of incomes for the poorer half of households in Figure 8.20 was a rising economic and political imperative to deliver at least part of ‘the American dream’ by widening access to homeownership to those unable to meet standard criteria required by lenders for the size of deposit and household income. The 2000s saw the spread of these so-called ‘sub-prime’ mortgages.

The bottom panel of Figure 8.20 shows the evolution of wealth for the same groups of households. Rising house prices during the 2000s increased the incentive and ability of existing homeowners to borrow, and sub-prime lending widened the pool of borrowers. As a result, those in the poorer half of the income distribution who had not experienced income growth but owned housing, did experience rising wealth via the capital gains associated with rising house prices.

There are two line charts. The first line chart illustrates the growth of income for three wealth groups: the poorest 50%, the middle 40%, and the richest 10%. The horizontal axis displays the years from 1950 to 2020, and the vertical axis shows the index of household income, ranging from 50 to 250, with 1971 as the base year (100). There are three lines, each representing one of the wealth groups. From 1950 to 1970, all three lines show a similar trend, increasing steadily from around 50 to 100. After 1970, the line for the poorest 50% shows a steady decrease, reaching a low of around 75 in the late 1980s. It then gradually returns to 100 by 2000 and remains around that level, with a slight drop to 90 in the early 2010s. The line for the middle 40% generally increases after 1970, reaching a peak of around 140 by 2016, despite notable drops in the late 1980s and early 2000s. The line for the richest 10% shows the most rapid increase after 1970, reaching nearly 250 by 2016, with similar drops in the late 1980s and early 2000s. The second line chart illustrates the growth of wealth for the same three groups. The horizontal axis displays the years from 1950 to 2020, and the vertical axis shows the index of household wealth, ranging from 50 to 450, with 1971 as the base year (100). There are four lines: three for each wealth group and a dashed line for the house price index, with 1980 as the base year (100). From 1950 to the late 1990s, the wealth lines for all three groups show a steady increase from around 50 to 150. After that, the line for the poorest 50% rises more slowly, peaking at 200 in 2006 before dropping dramatically to around 75 in the early 2010s. It then gently recovers to nearly 100 by 2016. The lines for the middle 40% and richest 10% increase more rapidly until around 2005. After peaking, the line for the middle 40% drops from nearly 250 to less than 200 in the early 2010s and recovers to around 225 by 2016. The line for the richest 10% drops from around 275 to less than 250 in the early 2010s and then soars to over 300 by 2016. The dashed line for the house price index shows the most rapid increase, rising from just above 50 in 1975 to over 375 in 2005, then dropping significantly to just above 300 in the early 2010s, and finally soaring to over 450 by 2020.
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https://www.core-econ.org/macroeconomics/08-financial-environmental-crises-08-inequality-us-housing-application.html#figure-8-20

Figure 8.20 The growth of income (upper panel) and wealth (lower panel) for three wealth groups: the poorest 50%, the middle to upper 40% (50–90%), and the richest 10%; for each group, 1971 = 100. The index of house prices is plotted in the lower panel (1980 = 100).

Moritz Kuhn, Moritz Schularick, and Ulrike Steins. 2020. ‘Income and Wealth Inequality in America, 1949–2016’. Journal of Political Economy 128 (9).

For those in the poorer half, wealth was 50% higher by the mid-1990s as compared with 1971, and grew again so that by the time of the financial crisis in 2008, it was double its 1971 value. It then fell to 60% of the 1971 benchmark and recovered little of the losses before the pandemic hit.

Wealth gains by the wealthier on the way up outstripped those made by the poorer half. With more diversified portfolios, wealthier households benefited from the rise in the stock market (as well as from capital gains on housing). For the richest 10%, the loss of wealth following the financial crisis was therefore much more muted, and by 2015 it was well above the pre-crisis level.

The inequality in the distribution of income and wealth in the US contributed to the conditions that led to the financial crisis. But the behaviour of banks, to which we now turn, was also crucial.

Question 8.7 Choose the correct answer(s)

Based on the information in Figures 8.18, 8.19, and 8.20, read the following statements and choose the correct option(s).

  • The household debt-to-income ratio is positively related to house prices.
  • The poorest 20% of households in the USA hold more debt (in absolute amount) than the richest 20% of households do.
  • Incomes for the poorest 90% of the U.S. population have stagnated since the 1970s.
  • The poorer 50% benefited from the housing price boom but have not yet recovered from the global financial crisis.
  • As shown in Figure 8.18, these two variables tend to move together in the same direction.
  • The chart shows percentages that sum to 100%, so we cannot compare absolute amounts across household groups. We can only say that the poorest 20% of households have much more debt than home equity compared to the richest 20% of households.
  • The incomes of the poorer 50% have stagnated, but the incomes of the middle to upper group (50–90%) have increased (though not as much as the incomes of the richest 10%).
  • The wealth of those in the poorer 50% fell to 60% of the 1971 benchmark during the global financial crisis and little of the losses had been recovered before the pandemic hit.