The hidden costs of recovery

By James Frazier

The S&P 500 index recently hit a new all-time record high, having officially recovered 100% of its financial crisis losses in about five years. This is good news for investors, pension holders, government officials, and corporate management, and congratulations is due for persevering through a market comeback that was far from assured. Yet, as a nation, we are still missing the feel of a truly prosperous and sustainable economy. Post-recession financial gains are far from widely distributed, and many people are worse off than they were five years ago. There’s a growing sense in our society that who benefits from the economy is just as important as the overall level of economic benefits themselves.

Let’s take a quick look at some indicators of economic health. Home values, the biggest component of household wealth, are still 23% below 2004-07 levels. After five years of recovery, the unemployment rate stands at 7.7% compared to a pre-crisis decade of unemployment consistently under 6%. Perhaps worst of all, from 2007 to 2010, the average wealth of the top 20% of American households relative to the bottom 80% expanded by an astounding 41%. Given how much the stock market has risen since 2010, that gap has grown much wider now. How can the stock market recover so well while leaving so many behind? I have observed two major reasons.

The first is that corporate management cut costs aggressively in a fight for survival during the recession.

Worker salaries and retirement benefits, some of the biggest corporate expenses, were slashed through layoffs and forced pay reductions.  Yet, after economic growth returned, overall wages were not restored to their former levels.  As a result, corporate profits have soared to 30% higher than their pre-recession record high.  The stock market has responded strongly.

The second reason lies with the Central Bank of the United States, the Federal Reserve.  Since the financial crisis began, the “Fed” launched a historic effort to stimulate the economy, involving two major parts.  One, by dropping interest rates to near-zero levels, the Fed has supported the ongoing rise in overall debt, while encouraging savers who depend on interest income to reach for more risky, higher-yielding investments.  Two, by creating unprecedented amounts of new money to buy US government and agency bonds (to the recent tune of $85 billion per month), the Fed has flooded the financial sector with money.

While it is difficult for even professional economists to precisely track the effects of the Fed’s policies, most financial professionals believe that the Fed’s actions have fuelled the multi-year rally in stocks and other risky assets.  The question is, has the run-up in stocks and debt benefited the economy and Americans in any broad sense?  Indeed, when asked last year how the Fed’s policies differ from trickle-down economics that help Wall Street, even at the expense of Main Street, Fed Chairman Ben Bernanke said:

“This is a Main Street policy, because what we’re about here is trying to get jobs going…. The tools we have involve affecting financial asset prices…like, for example, the prices of homes. To the extent that home prices begin to rise, consumers will feel wealthier, they’ll feel more disposed to spend…. Stock prices—many people own stocks directly or indirectly. The issue here is whether or not improving asset prices generally will make people more willing to spend.  One of the main concerns that firms have is there is not enough demand, there’s not enough people coming and demanding their products. And if people feel that their financial situation is better because their 401(k) looks better or for whatever reason, their house is worth more, they are more willing to go out and spend, and that’s going to provide the demand that firms need in order to be willing to hire and to invest.”

Not to second-guess Chairman Bernanke, but encouraging run-ups in asset prices in order to spur the economy seems like a dubious, perhaps even dangerous strategy.  After all, the cause of the last financial crisis was an unsustainable run-up in housing prices that many felt was the Fed’s primary responsibility to rein in.  This time around, once again, unintended consequences abound.  For example, armed with easy money and the prospect of rising home prices, professional investors have been snapping up homes across the country.  According to the Wall Street Journal, these investors “expect the number of families locked out of homeownership—because they don’t have strong enough credit or savings to qualify for a mortgage—will continue to grow.”  As a result, the homeownership rate continues to fall, and in the future, more Americans will be renting their homes from Wall Street fund managers than ever before.

As for the idea that rising stock prices will help the economy, it is decidedly not a Main Street strategy.  The bottom 80% of Americans by wealth own just 8% of all stock owned by Americans, and less than half of that (3.5%) is held outside retirement accounts.  Since retirement accounts are built up over decades and spent very slowly over more decades, that leaves only a miniscule amount of immediately spendable stock profits in the hands of the vast majority of Americans.  It is disturbing that the Fed intends for Americans to consume more based on these meager profits and higher retirement account balances, when it’s already well established that Americans aren’t saving enough for retirement.

On the plus side, it does appear that the Fed’s policies have helped encourage businesses to hire and invest, though at a tepid pace compared to past recoveries.  It’s possible this improvement will continue, ultimately delivering more widely distributed job opportunities and wage increases.  The big question is, will it happen soon enough to preserve our sense of America as the land of equal opportunity for all?  Or will the hidden costs of this recovery permanently cement the wealth divide?

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James Frazier

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