Do different financial crises affect different economic classes?
May 7, 2017 4:33 AM   Subscribe

I'm poor, so the great recession of 2008 didn't affect me too much. I was poor before and I'm still poor. It also didn't seem to affect the rich very much. It was almost as if it was targeted to the middle class and almost middle class. Are there different types of financial disaster that can affect different groups of people?

Specifically, is there a type of crisis that would only hurt rich people? Is there anyway the robber-barons will ever reap what they have sown?
posted by ambulocetus to Work & Money (19 answers total) 7 users marked this as a favorite
Absolutely. The 2008 crisis hit the middle class hardest because it primarily affected housing. If you didn't own a house, you probably still felt some effects (it was harder to find an apartment at the time, because so many former homeowners had to rent), but overall it probably wasn't cataclysmic for you. For most Americans, though, a house is their biggest investment, and by far the largest component (often the only component) of their net worth. The super-rich, meanwhile, weren't affected as much because, even if they own multiple mansions, there is much more to their net worth than residential real estate. Part of the way you get to be super-rich is by diversifying your portfolio.

And that's why it's unlikely that there'll ever be a financial crisis that's as hard on the rich as 2008 was on the middle class. You'd have to have something that primarily affects assets held only by "high net worth individuals", to use a term from the megabank I used to work for, and affects the majority of their portfolio. Hard to do because of diversification, but also, because the rich are spreading the risks of things like stock ownership among the middle class population through things like 401ks. So while a stock market crash would screw a lot of rich people, it would also screw a lot more middle class people whose retirement is in stocks too. As I understand it, this is actually one of the primary motivations of expanding things like stock ownership (e.g., privatizing social security): to create a sort of false class consciousness among the middle class that their interest are the same as the interests of the super-rich.
posted by kevinbelt at 5:20 AM on May 7, 2017 [13 favorites]

The other thing is that even if individual rich people haven't diversified, the overall group of rich people has. There are a lot of ways you could be rich. You could own and develop real estate; you could have a Scrooge McDuck money bin; you could invent Harvard Connection, I mean Facebook. If the tech bubble (yes, there is one) bursts and Facebook's value goes to zero tomorrow, Scrooge and Trump would still be rich. If there's hyperinflation and money becomes essentially worthless, Scrooge would have nothing but an uncomfortable swimming pool, but Zuck and Trump would still be rich. If people decide they no longer want office towers in Manhattan or cheesy casinos in Atlantic City, Trump might go broke, but Scrooge and Zuck are still sitting pretty. There are few things that can cut across industries like this without also affecting the middle class.
posted by kevinbelt at 5:31 AM on May 7, 2017 [3 favorites]

Specifically, is there a type of crisis that would only hurt rich people? Is there anyway the robber-barons will ever reap what they have sown?

One of the reasons that the middle class can be wiped out by a real estate crash is that their asset is backed by debt. Specifically for a lot of people, their asset was backed by short term debt (a 5 year adjustable rate mortgage) intended to be paid off over the long term (rolled over to a new short term mortgage for the next 30 years or until sold). The recession caused the devaluation of their home, so they could not refinance the mortgage, because the bank won't lend money to mortgage something for more than it was worth. It couldn't be sold because the value fell and the sale wouldn't be enough to pay off the loan. And then they lost their jobs, which they needed to make payments on the mortgage. This all is a formula for insolvency.

In general(*), the wealthy don't have debt underlying their personal assets. Their cars and homes are paid for in cash, and any relatively minor debts can be paid for with liquid assets. For a wealthy person, anything that is leveraged with debt as much as a middle class person would be a corporation or otherwise liability-limited entity that itself could go bankrupt but without touching the personal assets of the owners.

In short: a rich person can generally be lose investments or have his net worth decline, but unlike a middle class person, does not have to worry about keeping up with loan payments or having creditors lay claim on his assets to repay the loans.

*exception: Trump in the 80s and the guy in the documentary "the queen of Versailles" went into personal debt, borrowing against their personal assets, to finance their companies. When the economy went south, theydid face personal insolvency, but even then, the banks realized that they stood to lose more money by foreclosing on those borrowers than they did by negotiating a deal and allowing them to dig themselves out of their hole, allowing them to pay back a decent fraction of their loans.
posted by deanc at 5:50 AM on May 7, 2017 [4 favorites]

Unless by "poor" you mean people who are so deeply impoverished that they're not really part of the formal economy any more -- ie doing odd jobs under the table instead of working an above-board job -- you're probably generalizing too much from your own circumstances. Shitloads of poorish people who were struggling but keeping their heads above water got wiped out when they lost their jobs (or got sick), and some of them never recovered. But maybe you're thinking of someone with a steady job as not really poor?

Also in some ways the 2008 crunch hit rick people hard too. Lots of them lost half or more of their money too. But take away 75\% of a rich person's money and they're still not homeless.

In general(*), the wealthy don't have debt underlying their personal assets.

Lots of people who are rich by normal human standards are in debt up to their eyeballs too. Think "radiologist with an especially big mcmansion and an exotic car," not Trump or Buffet.
posted by ROU_Xenophobe at 6:06 AM on May 7, 2017 [5 favorites]

Isn't it simply that someone with a net worth of, say, $10M, can lose half of that or more and still be considered rich? Whereas someone with a net worth approaching zero (because of debt and little savings) quickly finds themselves underwater in a downturn?

The stock market fell 50% from peak to trough during the 2008 crash. This hit a lot of people that most would consider rich. But they were still pretty rich after losing ~50% and they could afford to ride it out.

I think this dynamic is why it is improbable that there would be a type of financial crisis that would hurt the rich but not anyone else - in general, the rich can afford to lose more (proportionally) than the non-rich and can afford to wait out a crisis.
posted by Mid at 6:06 AM on May 7, 2017 [1 favorite]

It also depends where in the world.

In Spain, lazy newspaper articles repeat the story of the "hollowing out of the middle class"* but, as sociologist Pau Marí-Klose shows, the people who have suffered the most in Spain are the poorest and the young. I don't have time to fish out references, but Klose's name above is linked to his Twitter account, and here's a search (in Spanish) for "effects crisis".

Lately even major newspapers have received the news. See "No es la clase media, es la clase baja".

* My theory is that this happens because of bias: the collapse of advertising in journalism, and the corresponding unemployment, has hit journalists hard, and they are middle class, so they generalise.
posted by kandinski at 6:10 AM on May 7, 2017 [5 favorites]

The chart that persuaded me shows variation in income in Spain between 2008 and 2011, by income decile. All are affected, but look at the lowest deciles.
posted by kandinski at 6:23 AM on May 7, 2017 [2 favorites]

I should add that there is one event that could disproportionately affect the wealthy, which is state-sponsored redistribution. This is why people spend more on accountants and lawyers to avoid taxes than they'd pay in taxes, and why even minor tax increases are met with apocalyptic rhetoric.
posted by kevinbelt at 6:46 AM on May 7, 2017 [26 favorites]

The reason the 2008 mortgage crisis wasn't hard on the rich is because we used taxpayer money to cover their losses. We did not use taxpayer money to cover any losses suffered by the middle class, who were allowed to lose their homes, jobs and savings.
posted by Autumnheart at 6:52 AM on May 7, 2017 [29 favorites]

Investment pyramid schemes - Madoff - tend to affect the wealthier. Sales pyramid schemes are a different story, of course.

The point above that the wealthy can ride it out, though, still applies. Specifically, the wealthy don't need their assets to live in/on, so they can hold them until value recovers. But if you're average Jane and you need to sell your house to move to a new job, or use any invested money in 2009, you were forced to cash in on a much lower value.
posted by Dashy at 7:03 AM on May 7, 2017

Heck one way the wealthy get wealthier is not just by holding on to assets through periods of volatility, but by acquiring assets in downturns from a distressed middle class. If you were in a position to buy stocks or real estate in 2009-10 you made out like a bandit.
posted by spitbull at 8:24 AM on May 7, 2017 [1 favorite]

And of course the LBO vulture capitalists similarly profited from the downsizing of workforces, as we know from the story of Mitt Romney and Bain Capital.

A downturn for the middle class is an opportunity for the rich.
posted by spitbull at 8:26 AM on May 7, 2017

I disagree that the middle class suffered more than the poor. That might be the case for you, but it isn't true for the vast majority of the poor.

All economic crises affect the poor more than the rich. There are a couple of reasons for this. First off, the poorer you are the less buffer you have to catastrophe. A minimum wage job might not be great but it is immensely better than no job at all. For the rich, losing half their wealth might be discomforting but it's not life threatening.

The second reason is that the wealthy write the laws and control the politicians. For example in 2008, all of the big investment banks should have been wiped out -- Goldman Sachs, JP Morgan, Morgan Stanley, etc. But they had their pal and alumnus, Hank Paulson at the Treasury to bail them out. Goldman Sachs was literally in the room when Treasury made those decisions. But no middle class citizens were in the room. He didn't bother to bailout the middle class citizens who were over their heads temporarily. That was a political choice.

Likewise, in 2005, the Republican Congress passed the Bankruptcy Act that made it much more difficult for middle class citizens to file bankruptcy and clear the slate to start a new life. These are political decisions that burden the poor and middle class but benefit the rich.

The wealthy will never suffer all long as they are politically protected.
posted by JackFlash at 9:44 AM on May 7, 2017 [2 favorites]

I agree that in many cases middle class people are affected more by a recession than poor people.

The reason is mortgages. Many middle class people have as little as 3% home equity. That means if house prices decline by even 5%, they're in serious trouble and have instant negative net worth. When you see 30% declines like we did in the last recession, large numbers of homeowners end up with negative net worth, owing tens or hundreds of thousands of dollars to the bank.

Poor people don't have that kind of massive leveraged exposure to the markets. If you're poor, you can certainly lose everything you have, but you can't really go negative in an economic crash.

Of course the government has historically been much more willing to bail out middle class people who became poor than people who were just poor all along. But if you ignore government intervention, middle-class people are definitely more at risk in a crash.
posted by miyabo at 11:15 AM on May 7, 2017 [1 favorite]

I agree that in many cases middle class people are affected more by a recession than poor people. The reason is mortgages.

Would you rather be a middle class person who loses their house and has to move into an apartment or a poor person who loses their minimum wage job and has to live on the street or a couch?

The middle class may lose more in absolute dollars, but the effect is always worse on the poor. You could also say that the rich lose more in absolute dollars, but you wouldn't say they suffered more than the middle class. Any recession that affects the middle class affects the poor even more.
posted by JackFlash at 11:38 AM on May 7, 2017 [4 favorites]

The only kind of 'catastrophe' that would have remotely the same impact on the wealthy as the 2008 recession did on the poor and middle class (BTW, cannot tell me it did not affect the poor. I nearly starved to death for the first few months after the bubble popped) are socialist tax policies that tax assets and income regardless of where they are held.
posted by thebotanyofsouls at 12:57 PM on May 7, 2017

I think it is easy not to see or grasp how much money was evaporated for rich people in the mortgage crisis. I haven't looked at the calculations lately, but literally billions and billions in RMBS and CDOs built on RMBS, which is an asset class most middle-class people have zero exposure to. With the notable exception of the handful that shorted those CDOs, many hedge funds dropped a ton of value, too. Most people have no visibility into this, but PE took an ass-kicking, as well, that it took years to climb out of. Their time horizon is longer than the average investor's, but their fees are based in large part on assets under management, which shrunk, and they are in perpetual fundraising mode, so they can't withstand investor flight for too long.

None of this is to evoke sympathy, for I have none, but it's a simple fact that the rich had more they could afford to lose and so they were less visibly wiped out. (And, of course, were adept in recovering.)

That means if house prices decline by even 5%, they're in serious trouble and have instant negative net worth.
When you see 30% declines like we did in the last recession, large numbers of homeowners end up with negative net worth, owing tens or hundreds of thousands of dollars to the bank.

This is why net worth is actually a fairly limited metric. Declines in housing prices don't create mortgage debt where none existed before. If I owe $200K to a bank on my house and my house's value drops from an estimated $250K to an estimated $180K, I don't suddenly owe the bank more. I still owe the bank $200K. My payments on the loan don't change based on the decline in value itself, either. If the 2006-era borrowers had had fixed-rate mortgages, they would only have gotten into "serious trouble" if their income had fallen to the point that they could no longer make the payments they could previously afford or they were otherwise compelled to sell (which, of course, did end up happening to many people, but largely as a knock-on effect of the initial failure of ARMs and the consequent collapse of the construction industry). If your loan is properly underwritten and you are not reaching its end, short-term housing price fluctuations should have little effect on your day-to-day life; your loan is calculated to be repaid, not through the sale of the asset, but through principal/interest payments over 30 years. What the middle class lost was the illusion of net worth supported by imaginary housing price appreciation. That in itself did not actually make them effectively poorer or get them in "serious trouble," because they never actually had that money. What blew borrowers up was interest-rate resets that they could never have afforded in the first place (or, in some cases, aggressive use of HELOCs that, unlike mortgages themselves, could be called in short of default). When you can't make your monthly payments, that's when you start going backwards, especially when you hit the point when you are forced to liquidate and see what your imaginary number turns out to be in reality.
posted by praemunire at 1:08 PM on May 7, 2017 [6 favorites]

All of that makes sense, but the declining house prices mattered more than you suggest because: (1) many people assumed they could always re-fi their way out of a bad ARM reset, which turned out to be wrong when house prices fell; and (2) if someone lost their job because of the downturn and could no longer afford the mortgage payment, the housing price declines could keep them "trapped" in a house and loan they couldn't afford, rather than just selling the house, cutting losses, and downsizing.

Also, I think you overstate the "they never actually had the money" point. If you have any non-cash asset, the value of the asset might rise and fall over time with the market. I don't know of any scientific way to say that someone's asset has a real value and someone else's asset is "illusory" money.
posted by Mid at 7:22 AM on May 8, 2017

Here's a specific example: Why the housing bubble tanked the economy and the tech bubble didn't. By Amir Sufi and Atif Mian, authors of House of Debt.
In 2000, the dot-com bubble burst, destroying $6.2 trillion in household wealth over the next two years.

Five years later, the housing market crashed, and from 2007 to 2009, the value of real estate owned by U.S. households fell by nearly the same amount — $6 trillion.

Despite seeing similar nominal dollar losses, the housing crash led to the Great Recession, while the dot-com crash led to a mild recession. Part of this difference can be seen in consumer spending. The housing crash killed retail spending, which collapsed 8 percent from 2007 to 2009, one of the largest two-year drops in recorded American history. The bursting of the tech bubble, on the other hand, had almost no effect at all; retail spending from 2000 to 2002 actually increased by 5 percent.

What explains these different outcomes? In our forthcoming book, “House of Debt,” we argue that it was the distribution of losses that made the housing crash so much more severe than the dot-com crash. The sharp decline in home prices starting in 2007 concentrated losses on people with the least capacity to bear them, disproportionately affecting poor homeowners who then stopped spending. What about the tech crash? In 2001, stocks were held almost exclusively by the rich. The tech crash concentrated losses on the rich, but the rich had almost no debt and didn’t need to cut back their spending.
posted by russilwvong at 4:29 PM on May 8, 2017

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