Art by Pete Ryan

An in-depth white paper published by PGIM Fixed Income in September shows that, since the global financial crisis of 2008 and 2009, U.S. households in aggregate have come a long way in strengthening their balance sheets.

Liabilities relative to disposable income have trended down to more sustainable levels, PGIM’s analysis shows. In tandem, household assets have surged as the value of financial assets and housing have increased. And, with the decline in liabilities and the rise in assets, PGIM Fixed Income reports, overall net worth has risen briskly and now exceeds pre-crisis levels at around 650% of disposable income. This equates to an average of over $800,000 for each U.S. household.

But, as the analysis starkly demonstrates, lurking under the surface of the data is a thorny issue of aggregation. Simply put, the distribution of wealth in the United States is highly unequal—about as unequal as it has ever been. Each household in the top 1% of the wealth distribution has, on average, $25 million of assets, including nearly $10 million of equities. The next 9% of the distribution holds an average of $3.5 million each, PGIM Fixed Income reports, supported by more than $1 million of pension entitlements, including defined contribution (DC) and defined benefit (DB) plans.

In marked contrast, the bottom half of households has only $20,000 of net worth, on average, a figure that represents less than 0.1% of those at the top. Such figures may not seem to be of direct professional concern to people working in the financial services field, who tend to be well compensated, but in fact they are. As PGIM Fixed Income reports, some “inequality of outcomes” can promote investment and risk taking, but if the wealth distribution in a society becomes too skewed, those toward the bottom may feel that the probability of rising is discouragingly low.

“Moreover, entire communities may not experience, at least in any first-hand way, the benefits of economic engagement through education, skill acquisition, employment and investment,” PGIM Fixed Income’s report explains. “This blunts incentives to participate in the traditional economy and, perhaps, provides incentives to play outside the system.”

The white paper further posits that highly unequal distributions of income or wealth may bring hidden vulnerabilities for the entire economy or the financial system—meaning in turn that even the wealthiest Americans have a direct stake in solving rampant income inequality.

“For example, the balance sheet data we report paints a very favorable picture of the U.S. consumer sector,” the paper states. “But, as we will show, households in the bottom 50% of the wealth distribution are really struggling. Given the limited financial resources of these households, they have few buffers to absorb a shock, especially a deterioration in labor market conditions [as seen during the coronavirus pandemic]. This means that the economy is more brittle than the aggregate data suggest and, notably, more brittle than if the same wealth was held evenly across the population.”

The white paper goes on to suggest that economic divergences of this type also manifest themselves in the political environment. And, when combined with social unrest related to racial justice issues, the outcome can be disastrous for everyone.

“Inequality economically disenfranchises those who are poorer, while the spending patterns of those at the top are economically far more significant given that they command exponentially more resources than those at the bottom,” the paper explains. “But in the ballot booth, the votes of the bottom 50% count exactly the same as those at the top. Thus, if the economic system is viewed as unfair, or is otherwise creating frustrations, this will manifest itself in the outcome of elections and, eventually, in government policies. The result could be policies that challenge or disrupt the existing economic order.”

When it comes to addressing these fundamental economic justice issues, the PGIM Fixed Income report points to two broad potential approaches—first, lifting the bottom portion of the distribution or, second, compressing the top of the distribution.

“For reasons of economic efficiency, we prefer the former approaches,” the white paper concludes. “Market economies rely crucially on the willingness of individuals to take risks and to invest capital. To operate at peak efficiency, it’s important for people to generally reap the benefits or shoulder the losses that flow from their decisions. However, given the breadth of the polarization that exists in the United States, policy measures that narrow the distribution by clipping the top are also on the table. Indeed, more fundamentally, these two approaches may not be entirely independent.”

In other words, measures to lift the lower portion of the distribution may need to be financed by increasing the burden of those at the top.

“Our regression results offer some hints as to possible steps forward,” the paper suggests. “First, over time, home ownership has proved to be one of the best ways for middle class families to accumulate wealth. This reflects both that housing allows broad access to a relatively safe, but leveraged, asset class. The capacity to accumulate wealth through buying a house has been significant. Of course, in the aftermath of the financial crisis, all of this is less certain than before. But we find the historical record to be compelling. On balance, our judgment is that policy initiatives to encourage broad-based home ownership are likely to help mitigate inequality over the medium to long run.”

A further observation made by PGIM Fixed Income is that, apart from accumulating a down payment, owning a home may not require a household to increase its saving, since rent payments can be converted to mortgage payments.

“In other words, home ownership allows families to adjust their financial footprint without disrupting their other consumption patterns,” the paper explains.

Beyond home ownership, the equity market has been a core driver of wealth for the upper portion of the income distribution, the white paper says. Indeed, the paper’s various regression analyses show that rising equity prices are a key factor explaining increasing inequality.

“The policy prescriptions should not focus on penalizing the stock market or those holding equities, but rather seek to expand the set of equity investors,” the paper concludes. “How this can be achieved broadly in the economy is very much an open issue. Over the years, a number of proposals to invest Social Security contributions in the equity market have been considered. But this entails enormous complications, including who is to bear the losses if stocks sag for extended period? Alternatively, employed workers generally have access to 401(k) or similar vehicles. Further policy focus on maximizing participation in these vehicles could include some form of tax credits (rather than just deductions) for contributions by lower-paid workers and their employers.”