Revised 2/25/22
Wealth inequality is even more extreme than income inequality. The income of the 75th percentile household in the United States is 3.5 times greater that of the 25th percentile. For net worth, it’s 32 times greater.
An important reason why the distribution of wealth is so uneven is that wealthier households tend to earn higher rates of return on their asset holdings than poorer households—known as the “return gap.” The timing of asset purchases contributes to this gap; wealthier households more often purchase assets when expected returns are high and sell them when they are low.
In my recent paper, I show how this timing mechanism operates in the case of real estate purchases, an important channel of wealth accumulation for families—especially those in the middle of the wealth distribution. I use a novel methodology from my previous research to predict wealth levels. I match surnames seen in deed records to publicly available historical Census income data, which is a strong predictor of surname-level average wealth today; this links home purchases to wealth levels. I find that poorer households are more likely to purchase real estate when prices are higher and sell when prices are lower. That is, they buy high and sell low more often than wealthier households, which widens wealth inequality.
While much recent work on wealth inequality focuses on the outsized role of the top 1%, patterns of poorly timed home purchases contribute to wealth inequality across a much wider swath of the population. In numerical terms, the difference in home purchase timing between the 75th and 25th percentile of household wealth accounts for a 60 basis point (or 0.6 percentage point) difference in annual expected returns. Considering that the rate of return on real estate for middle-wealth households averages around 3.3% (based on research by Inês Xavier), asset purchase timing accounts for a substantial difference in returns.
A more volatile economy has larger peaks and troughs in home prices, meaning poorly timed home purchases result in larger differences in returns and higher wealth inequality. In metropolitan areas that have experienced bigger booms and busts—think Las Vegas in the mid-2000s—poorly timed asset purchases matter more. Consistent with that logic, these areas have higher wealth inequality relative to income inequality than less volatile regions.
Home purchase timing also differs across racial groups, and I find that racial minority households are more likely to “buy high and sell low.” This result suggests that racial minorities may be especially vulnerable to boom-and-bust cycles and that counteracting poorly timed asset purchases could also help narrow racial wealth gaps, in addition to reducing overall wealth inequality.
More concretely, it suggests that efforts to counteract patterns of poorly timed home purchases and distressed sales include: 1) ensuring smooth and consistent access to credit throughout the business cycle and 2) reducing business cycle volatility. It also suggests that the benefits of such efforts would likely flow to poorer and middle-wealth households, as well as to the broader economy.
Smooth and consistent access to credit through the business cycle
In the context of my paper, poorly timed purchases can be exacerbated when mortgage credit is procylical—that is, cheaper or more widely available during economic “booms” and more costly during “busts.” When this is the case, households with lower levels of wealth may be more likely to purchase homes when prices are high and expected returns are low. Or they may be more likely to sell or lose their homes to foreclosure when prices are low and expected returns are high. Also, when access to credit varies procyclically over the business cycle, interventions to boost poorer households’ wealth may be less effective when they occur during boom times but not during downturns. Smooth and consistent access to credit throughout the business cycle would potentially make poorly timed purchases less likely. One area to further explore is the extent to which countercyclical access to credit can lead to better timed purchases, particularly for households with lower levels of wealth.
Reducing business cycle volatility
My finding that the more volatile a local economy is, the greater the excess of wealth inequality over income inequality tends to be, suggests that reducing overall business cycle volatility might reduce wealth inequality at the national level. Strong automatic stabilizers during downturns offer one possible approach to reducing the depth of business cycles. For example, robust unemployment insurance or increasing housing assistance could help homeowners avoid losses during downturns by reducing the scope for distressed sales. Such interventions could counteract patterns of poorly timed asset purchases among less-wealthy households and potentially reduce wealth inequality. Designed appropriately, stronger automatic stabilizers may also support a broader macroeconomic recovery.
To learn more, download the full paper.
