Partners (Fall 1998)

Bringing Income Inequality
in from the Cold

The Importance of Building Assets

Marie Easley

As we pick up our local newspapers and listen to the national news, we become increasingly aware that industrialized countries, including the United States, are experiencing growing income inequality. This widening disparity was the topic of Federal Reserve Board Chairman Alan Greenspan's opening remarks at a Jackson Hole, Wyoming symposium sponsored in August by the Federal Reserve Bank of Kansas City.

In his remarks, Chairman Greenspan acknowledged that the familiar and widely accepted explanation is that rising demand for workers who can effectively harness new technologies has been outpacing supply. Consequently, the logic goes, the compensation of those employees has been increasing at a quicker pace than for those with lesser technological skills.

However, in discussing the extent to which large portions of the population are not reaping the benefits of economic growth - even within groups of workers with similar measured skills - Greenspan cautioned that we cannot stop with an analysis of trends in earnings — or, for that matter, even trends in income more broadly defined.

"Ultimately, we are interested in the question of relative standards of living and economic well-being," he said. "Thus, we need to also examine trends in the distribution of wealth, which more fundamentally than earnings or income, represents a measure of the ability of households to consume."

The Federal Reserve's Survey of Consumer Finances suggests that inequality in U.S. household wealth - that is, in net worth - was somewhat higher in 1989 than at the time of the initial 1963 survey. The 1992 and 1995 surveys showed that wealth inequality remained little changed in terms of the broad measures. However, that stability masks a lot of churning among the subgroups," the Chairman cautioned.

The Federal Reserve's research using the survey suggests that conclusions about the distribution of wealth are sensitive — although to a lesser degree than income — to the state of the economy and to institutional arrangements for saving. For instance, among the wealthiest one-half percent of households, business assets - which tend to be quite cyclical - are particularly important. At the other end of the distribution, owned principal residences - thevalues of which are not as sensitive to business cycle conditions - are a typical household's most important asset.

Greenspan went on to say that, if we expand the definition of wealth to include estimates of Social Security and pension wealth, the distribution among U.S. households becomes much more even. This suggests that, in addition to factors influencing private wealth accumulation, the evolution of institutional arrangements for saving that has taken place over the last two decades may have played an important role in affecting changes in the distribution of wealth over time.

"What about the effect of the recent rise in stock and bond market values", the Chairman questioned. "The typical view is that the growth in mutual funds and other financial investments has allowed individuals further down in the wealth distribution to take advantage of strong equity markets. Our figures certainly show that households lower in the income distribution are now more likely to own stocks than a decade ago."

However, between the 1992 and 1995 surveys, the data showed that the spread of stock ownership and the rise in prices did not lead to a rise in the ownership of stock and mutual fund assets by the bottom 90 percent of the wealth distribution. Although their dollar holdings rose rapidly, the increases were not as large as those for households at the top of the wealth distribution.

"Thus, we need to also examine trends in the distribution of wealth, which more fundamentally than earnings or income, represents a measure of the ability of households to consume."

Mr. Greenspan noted, "If the patterns of equity ownership have not changed much since 1995, the steep rise in stock prices over the past several years would suggest a further increase in the concentration of net worth. This may be offset, to some extent, by a continued broadening in the ownership of equities, particularly through tax-deferred savings accounts. Some additional offset may have occurred through rising house prices, an important asset of middle class families. Our 1998 survey, which is now in the field, will yield a clearer reading both on how wealth concentration has changed and on the relative importance of different assets in that change."

The Federal Reserve Board Chairman concluded his remarks by saying that as we consider the causes and consequences of inequality, "we should also be mindful that over time, the relationship of economic growth, increases in standards of living, and the distribution of wealth has evolved differently in various institutional and political settings. Thus, generalizations about the past and future may be hard to make, particularly in the current dynamic and uncertain environment of economic change."

"Sustaining a healthy economy and a stable financial system naturally permits us to take the time to focus efforts on addressing the distributional issues facing our society and on other challenging issues that may remain out in the cold."

The Importance of Assets

As Chairman Greenspan suggested in his Wyoming speech, there is still much we do not know about the role of assets in income inequality. What we do know, however, is that households with assets clearly have had opportunities to benefit from economic growth that those without assets have not. And while stocks have recently surpassed home equity as the main form of household wealth, homeownership remains the cornerstone of financial security for most Americans.

According to The State of the Nation's Housing 1998: By the Harvard Joint Center for Housing Studies, nearly two-thirds of all U.S. households own homes. In contrast, only about 40 percent of American households own stocks. Furthermore, the U.S. Bureau of the Census recorded that the average home price in 1978 was $62,500. In 1997, it was $175,500.

Like any investment, homeownership is not without risks. Nonetheless, the almost 200 percent increase in average home prices over two decades suggests that owning a home does provide a valuable mechanism for creating wealth. While the tax advantages of mortgage interest deductibility and favorable capital gains treatment may not be of as much value to low- to moderate- income households, a family's home can still serve as a vehicle for building equity. In addition, the ability to take advantage of fixed-rate mortgages and lock into fixed payments on the home at today's prices creates a hedge against escalating property values and rents. Nationally, mutual funds and defined contribution pension plans are a substantial source of asset-building, but they are not as widely available across the income spectrum. Even homeownership is inaccessible to many lower income individuals, because of the absence of savings for a downpayment and closing costs.

The importance of assets needed to build net worth has spawned a number of savings strategies across the country, in local communities and in public policy. Recently, Congress passed legislation on Individual Development Accounts (IDAs) that allows states to create community-based IDA programs with state block grant funds. The bill provisions also disregard all money saved in IDAs from affecting eligibility for government assistance.

Individual Development Accounts As An Asset-Building Strategy

Individual Development Accounts, or IDAs, are restricted savings accounts for low- and moderate-income persons, for which a match is provided, usually through a nonprofit organization or government entity. Their purpose is to help lower income families build assets in much the same way that middle America uses a 401(k).

Under the programs, consumers deposit savings from their salary or wages over time, the match is guaranteed and the funds can be withdrawn for an agreed upon purpose, such as the down payment on a home, post secondary education, or to help capitalize a small business. A very important by-product of the programs, however, is the economic literacy they provide through the requirement for completion of financial and home ownership education programs. This education in financial investments is key to future success for the heretofore financially unsophisticated.

The Ford Foundation's Asset Building Focus

In a recent press conference to announce a new asset-building partnership (among the Ford Foundation, Self-Help, a North Carolina-based nonprofit community development organization, and Fannie Mae Corporation), Ford Foundation President Susan V. Berresford reiterated the crucial nature of financial assets to the economic well-being of families.

Financial assets provide "a cushion against unexpected expenses or crises, thereby helping to increase family stability. These assets also promote upward mobility, enabling household members to invest in their future in a variety of ways — pursuing an education or advanced training, starting a small business, or purchasing a home."

The U.S. Bureau of the Census reported that the average home price in 1978 was $62,500. In 1997, it was $175,500.

Recognizing the importance of assets has led the Ford Foundation to develop new strategies that assist low-income people to build assets. One of the foundation's earliest efforts, announced in April of 1997, involved support for a major national demonstration of Individual Development Accounts.

Ms. Berresford noted that, while promoting increased levels of homeownership among low-income households represents another promising approach to asset building, the low level of financial assets among low-income and minority households is a significant barrier to expanding homeownership. She explained that, while the average U.S. household has a net worth of $43,000, low-income households have a median net worth of $5,000.

"This means that many who are reliable monthly rent payers often lack the required down payment for a home or have spotty credit records, stemming from their inability to pay unexpected expenses in a timely fashion. This is the problem our partnership aims to address in a 5 year demonstration, she says. The payoff is huge if it can open up lending policy across the nation to enable thousands of others to own a home."

Assets in the Broader Scheme of Things

In the future, family security for all Americans will likely be based more and more on personal savings accounts, such as expanded 401(k)s, IRAs, medical savings, and a probable shift toward supplementing savings in Social Security.

Michael Sherraden, Director, Center for Policy Studies at Washington University in St. Louis, notes in his report, Stakeholding: A New Direction in Social Policy, "because the world puts such a premium on knowledge and brain power, the wherewithal to pay for post secondary education or training may be the single most important financial asset anyone can have."

Yet college costs today are rising faster than inflation, beyond the reach of many low- and middle-income families. According to Sherraden, "Since 1980, tuition costs have risen by about 40 percent after inflation, while median family income has increased by just 6 percent. Meanwhile, federal student aid has grown by 18 percent after inflation."

Sherraden goes on to say in subsequent works that entitlement spending at current levels is unsustainable, and portable savings accounts will be more adaptable in the 21st century economy.

"However, it will be essential to bring all Americans into this emerging asset-based policy. The danger is that poor people will be left out when this transition occurs. Failing to do so would be a tragic loss for the country in reduced citizen participation and declining economic productivity."


As you will see discussed in other portions of this newsletter, assets take on many forms; but, their cultivation and the psychic dividend that results - turning a population's focus to the long term - is of the utmost importance.
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