The Big Idea

Sharing the wealth

Stephen Stanley | October 28, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The sharp drop in economic activity from 2020 Covid lockdowns and the subsequent explosive rebound had many unique elements. One of the most striking was the combined monetary and fiscal policy impact on household finances.  In particular, the unprecedentedly aggressive fiscal response to the pandemic, which was mostly means-tested, boosted the balance sheets of lower-income households in a way that continues to have important implications for the outlook on consumer spending and consumer-related debt.

Cyclical monetary and fiscal policy

The consensus among economists until the 1970s was that fiscal policy was a potent vehicle—and perhaps the best vehicle—for managing business cycles.  However, in the 1980s and 1990s, thinking shifted, with monetary policy becoming the preferred option for fine-tuning the economy.  In fact, demand-focused fiscal stimulus was barely considered at all for close to 20 years. As an extreme example, in 1990, in the middle of a recession, Congress and President Bush passed a tax hike to shore up federal finances.  However, lawmakers began to tiptoe back into the business cycle management game in the 2000s, with rebate checks and a major stimulus package in 2009.  The fiscal response during Covid dwarfed anything seen in recent history, as the government distributed trillions of dollars to households and businesses to keep the economy afloat after government-imposed lockdowns.

Monetary policy tends to mostly benefit upper-income households, at least initially, through asset valuations.  That skew was accentuated further with the advent of Federal Reserve asset purchases, which worked explicitly by boosting asset prices.  As a result, in recent cycles, lower-income households for the most part had to wait until the economy recovered sufficiently to create a hot labor market before they saw substantial benefits from countercyclical monetary policy.

Things were quite different during the pandemic. The bulk of the fiscal largesse was targeted to the bottom half of the income scale, as rebate checks were means-tested and supplemental unemployment benefits, by definition, went to households that lost their jobs.  As a result, household finances came out of the pandemic in extremely good shape, not only at the high end of the income scale, where surges in stock and home values boosted wealth but also for middle- and lower-income households.

Liquid assets by income quintiles

I have in the past often highlighted the aggregate data from the Federal Reserve on household balance sheets that show an extraordinary level of liquid assets, defined as bank deposits plus money market fund holdings.  The pre-pandemic uptrend in the series, if extended to the current period, would imply holdings of around $14 trillion.  The actual Q2 reading was $18.5 trillion, so households have more than $4 trillion in readily spendable liquidity above and beyond what might be considered “normal.”

The Fed also publishes the balance sheet data broken down by income quintile.  The following six exhibits show the level of liquid assets for the following groups along the income scale: the top 1%, 80% to 99%, 60% to 80%, 40% to 60%, 20% to 40%, and 0% to 20%.

Exhibit 1: Liquid Assets – Top 1% by Income

Source: Federal Reserve.

Exhibit 2: Liquid Assets – 80% to 99% Income

Source: Federal Reserve.

Exhibit 3: Liquid Assets – 60% to 80% Income

Source: Federal Reserve.

Exhibit 4: Liquid Assets – 40% to 60% Income

Source: Federal Reserve.

Exhibit 5: Liquid Assets – 20% to 40% Income

Source: Federal Reserve.

Exhibit 6: Liquid Assets – 0% to 20% Income

Source: Federal Reserve.

These pictures reveal a few key observations.  First, for the most part, the extraordinary boost to household liquid assets is spread relatively evenly across the income scale.  Every quintile except the bottom quintile has seen a sharp increase in liquid assets since the end of 2019.  The table just below shows the cumulative percentage increase in liquid assets by income group.  To put these gains into context, nominal GDP in the second quarter of this year was about 16% higher than at the end of 2019.  Thus, every quartile except the bottom quartile has grown their liquid assets at a pace of at least close to double the expansion in the overall economy.

Exhibit 7: Liquid Assets Increases by Income Cohort

Source: Federal Reserve.

At the top of the income scale, the move into liquid assets may well be, at least in part, an investment strategy.  It may be the case that wealthy households have taken money out of riskier assets, such as stocks, and parked in cash equivalents for a time.  However, for households in the middle class and even the fourth quartile, the accumulation of liquid assets is more likely a sign of heightened purchasing power.

The bottom quintile

The outlier in this analysis is the bottom quintile. This group saw their liquid assets jump in the first half of 2020 by about 10%, or $60 billion, likely reflecting the first round of rebate checks and supplemental unemployment benefits, which, for many in this group, would have exceeded their pre-pandemic paychecks.  Their liquid assets roughly held steady at the elevated level through the end of 2021, but in the first half of 2022 sank back to about the end-2019 level.

One key factor contributing to this runoff in liquid assets in early 2022 has undoubtedly been the surge in inflation, which tends to impact lower-income households harder because they spend most or all of their income on necessities like food and energy that have seen some of the largest price hikes over the past year.  Fed officials have emphasized that their resolve to get inflation under control is in part aimed at helping this cohort, even as some in this group will suffer from a cooling labor market.

However, it is not all bad for the bottom cohort.  They put their windfall to work.  The real estate values held by the bottom quintile surged from $1.7 trillion at the end of 2019 to $2.9 trillion by mid-2022, a 72% jump.  For all households, the rise was only 37% over that period.  Similarly, the bottom quintile’s holdings of household durable goods increased from $335 billion to $514 billion over the period, a 53% rise (for all households, the advance was 34%).  So, the bottom quintile largely spent their windfall, but they do have plenty to show for it.

Consumer spending and consumer debt

A frequent refrain this year has been that consumers are tapped out because the savings rate has dropped to levels below pre-pandemic trends.  However, these data convincingly refute that argument, at least for the top 80% of the income scale, i.e., households that account for the bulk of consumer spending.  Indeed, the vast majority of households still have extraordinary resources available, which may help to explain why consumer demand has continued to rise moderately in real terms despite all of the headwinds hitting household finances this year.  Moreover, I look for consumer spending to continue to grow at a similar pace over the next few quarters.

For potential investors in consumer debt, the pandemic created an unprecedented situation, as there were foreclosure moratoriums and a blanket deferral of student loan payments along with a massive influx of fiscal stimulus.  As the pandemic has faded, things are getting back to normal.  Delinquency and foreclosure rates have rebounded, though mostly only back to the (very low) pre-COVID levels.  These data would suggest that most households with middle and high incomes will have the wherewithal to fulfill their obligations, even in the face of much higher borrowing rates.

However, the erosion of the extraordinary cushion among families in the bottom quintile of the income scale suggests that these households, who would in general be most vulnerable to running into debt load troubles in any case, could soon begin to face heightened stress in servicing their obligations.  Thus, even if the aggregate credit numbers remain healthy, investors may be well served to keep a close eye on their exposure to lower-income households.