RIDING HIGH ON THE MARKET

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Our financial assets skyrocketed during the 1990s. So did our debts. Will we crash during the next stock market downturn ?

It's a broken record, literally. Two months ago, the economic expansion became the longest-running boom in American history - 107 months, and still ticking. Unemployment is at a 30-year low, inflation remains under control, and American households are richer than ever. The median net worth of the average household rose an inflation-adjusted 20 percent during the past decade, as stock market gains boosted wealth.

Surely, this is the best of times. But is our toehold on the good life secure, or will our newfound wealth disappear during the next bear market? Even more worrisome, with the amount of debt held by the average household rising rapidly, do many of us risk bankruptcy during the next recession? Maybe not, some experts say. "If the market declines, in general, people will not be in trouble," says David Orr, chief economist at First Union Corporation in Charlotte, Virginia. "They will be in trouble only to the extent to which they have borrowed against their stocks."

Orr explains: "If you put $10,000 in the market and it doubles, you've done well. If it drops in value, that's a disappointment. But if you put $10,000 into the market, watch it double and then borrow against it, you're in for a big disaster if the share value drops."

Other economists are not so sanguine. "The well-documented `wealth effect' - the situation that exists now, in which people are wealthier on paper because of huge market gains - is something to be considered," says Jacob De Rooy, associate professor of economics at the School of Business Administration at Capital College, Harrisburg. "It's important because it stimulates real spending. As their paper assets increase, people feel more confident about taking on more debt or borrowing more against their paper worth. But if the market falls, it will have a profound negative effect."

Who's right? One of the best ways to measure the financial security of Americans is to examine how the average household is doing - its savings, debt, and net worth. Fortunately, we have a tool for doing just that.

The Federal Reserve Board's triennial Survey of Consumer Finances provides the most comprehensive data available on the wealth of American households. The survey examines the components of household assets and debts, revealing just how exposed we are to a stock market downturn. The latest survey data, for the year 1998, were released in January. The Federal Reserve Board interviewed a nationally representative sample of more than 2,000 households, along with a supplemental sample of wealthy households because they control the most assets. The results are both startling and reassuring.

THE MARKET BOOM

In recent years, the action has been in the stock market. Many Americans have gone along for the ride and profited handsomely.

The value of the financial assets owned by the average household rose 36 percent in the three years between 1995 and 1998, after adjusting for inflation, growing from a median of $16,500 to $22,400. Financial assets include such things as stock, retirement accounts, mutual funds, savings and checking accounts, CDs, and the cash value of life insurance.

Nonfinancial assets (homes, cars, business equity, and so on) still account for the bulk of household wealth. But the financial share is growing, rising from just 30 percent in 1989 to 41 percent in 1998. More important, among financial assets, the share held in stocks, mutual funds, and tax-deferred retirement accounts, and other managed assets rose from 48 percent in 1989 to an eye-popping 71 percent in 1998, according to the Federal Reserve report.

Nearly 49 percent of households owned stock directly or indirectly in 1998, up from 32 percent in 1989. Among owners, stocks accounted for the 54 percent majority of financial assets in 1998, up sharply from the 28 percent of 1989. The bottom line: Americans are seriously playing the stock market, but some are more serious about it than others.

The majority of households with incomes of $25,000 or more own stock - either that of individual companies or stocks held by mutual funds and retirement accounts. Among households with incomes of $50,000 to $99,999, fully 74 percent own stock, as do 91 percent of those with incomes of $100,000 or more.

Granted, the median value of stock owned isn't all that impressive: America's stock-owning households have a median of just $25,000 in the market. But this is up from $10,800 in 1989. Households with incomes of $100,000 or more have a median of $150,000 in stock holdings, accounting for 63 percent of their financial assets.

But while many Americans pride themselves on their stock market gains, they're only fooling themselves if they think they're rich. "In reality, you're not rich until you generate sufficient capital off of your investments to sustain the style of living you want to have," says Marshall Acuff, equity strategist at Salomon Smith Barney in New York City. "Many people have accumulated some wealth in stocks, but not nearly enough to sustain a certain lifestyle long-term."

And, Acuff points out, the general feeling of well-being that people have about their financial wealth is based on the assumption that the market will continue its bull run year after year after year. "The real risk here is people's expectations. Their expectations are on the high side - they don't think that the market can go down significantly, and that's worrisome. People think they can do it on their own - buy individual stocks instead of mutual funds, and beat financial analysts' predictions. That's too optimistic," Acuff asserts.

William E. Whitesell, Stager Professor of Economics at Franklin and Marshall College in Lancaster, Pennsylvania, agrees: "For some people, it seems like a lot. Especially when people see their pensions tied to the market, they see real wealth. That has caused a lot of people to borrow against their investments, and as they borrow, they anticipate that the `wealth effect' will last into the future."

HOUSING: STILL NUMBER ONE

So, is our large and growing involvement in the stock market an accident waiting to happen? Have we overcommitted ourselves to the future prosperity of corporations, abandoning the more traditional and conservative foundation of wealth - real estate? In fact, homes remain the single-most valuable asset owned by the average American household, although their importance is diminishing. The primary residence accounted for 28 percent of the total assets of the average household in 1998, down from 32 percent in 1989. The value of other nonfinancial assets, such as vehicles, business equity, and so on, is relatively small. With financial assets growing as a share of total assets, nonfinancial assets are by definition losing ground. In 1989, nonfinancial assets accounted for 70 percent of the total assets of the average American household. By 1998, the figure had fallen to 59 percent.

Between 1995 and 1998, the median value of the nonfinancial assets owned by the average household rose 11 percent after adjusting for inflation, from $88,100 to $97,800. Behind this increase was the rise in homeownership to a record high. According to the 1998 Survey of Consumer Finances, 66.2 percent of American households own their home, up from 64.7 percent in 1995. The average home was worth a median of $100,000 in 1998, up from $95,600 in 1995, after adjusting for inflation.

No other nonfinancial asset even comes close in importance to the owned home. While a larger proportion of households (82.8 percent) own vehicles than own a home, the median value of vehicles stood at just $10,800 in 1998. For some Americans, however, the home has become something to spend against. "It's seductively easy to spend the credit you've got in your home," says Capital College's De Rooy. "Home equity lines of credit - loans against the value of the house - these are ways in which homeowners can spend the money their homes represent."

De Rooy points out that there is more liquidity of wealth now than ever before, and it is easier than ever to turn our wealth into liquid form. "I am concerned that this conversion from nonfinancial assets to financial assets will make people more vulnerable to any changes in the market," he says. He also theorizes that the current trend of consolidating all liquid wealth in one bank, brokerage house, or insurance company puts Americans at risk. "Having all of your assets under one roof makes it very easy to spend. The ease of being able to move money around can allow you to take advantage of positive trends in the market, but it also makes it too easy to access your wealth - and the potential for making mistakes in investment strategies is even greater."

DEEPER IN DEBT

Home values and stock holdings don't mean much if people owe more than they own. Surprisingly, the trend has been in the opposite direction; the assets of Americans are growing faster than their debt. But there's no denying this fact: Our debt is growing rapidly. The amount of money owed by the average household rose a whopping 42 percent in the three years between 1995 and 1998, from $23,400 to $33,300 after adjusting for inflation. And fully 74 percent of U.S. households are in debt. "The percentage of debt is not that significant," says Professor Whitesell. "But in absolute terms, the debt in this country is enormous. If consumers see their share of wealth decline, they will become concerned about their absolute wealth levels and cut back on consumption. A serious downturn on the basis of a readjustment of share prices is a real cause for concern."

Fortunately, most household debt is secured by home equity. Home-secured debt (mortgages and home equity loans) accounted for 72 percent of the money owed by the average household in 1998. But as De Rooy has cautioned, having easily accessible home equity may cause some people to overextend themselves. "Home equity lines of credit are practically being forced on us," he says. "And you can spend your real estate really quickly."

Installment loans (such as car loans) accounted for just 13 percent of all debt in 1998, while outstanding credit card bills accounted for only 4 percent of what people owe. The percentage of households with installment loans fell slightly between 1995 and 1998, as borrowers shifted to home equity loans for their tax-deductible interest. The percentage of households carrying a credit card balance also fell between 1995 and 1998 from 47.3 to 44.1 percent. The median amount of outstanding debt on credit cards barely changed during those years, rising from $1,600 to $1,700 after adjusting for inflation. Those most likely to be in debt are the affluent and the middle-aged.

THE BOTTOM LINE

All in all, the balance sheet looks pretty good. Because assets grew faster than debt during the economic boom of the 1990s, the average household is wealthier today than it was a few years ago. Median net worth (a household's assets minus its debts) stood at $71,600 in 1998, up from $59,700 in 1989, after adjusting for inflation - a 20 percent gain.

Older householders have been the only ones to advance in net worth, however. Householders aged65 to 74 saw their net worth grow an inflation-adjusted 51 percent between 1989 and 1998, while those aged 75 or older enjoyed a 36 percent gain. In contrast, the net worth of householders aged 55 to 64 grew only 2 percent, while the net worth of householders under age 55 actually fell. Behind the poor showing in the net worth category among those under age 65 was the rise in homeownership, with more householders taking on mortgage debt. As these homeowners pay off their mortgages in the years ahead, their net worth will climb sharply.

With net worth rising or poised to rise, and with little increase in any but home-secured debt, Americans appear to be playing their cards right. The Survey of Consumer Finances found a slight increase between 1995 and 1998 in the percentage of households that save, growing from 55.2 percent to 55.9 percent. While the increase is tiny, it shows that many Americans are restraining themselves even during boom times.

But not all. "Some people have adopted a `casino mentality' in this market," says Salomon Smith Barney's Acuff. "They are indulging more in speculation than in investment. For example, I heard about a 63-year-old man who decided that he didn't have enough money for retirement. He took loans against his credit cards, home equity loans, and whatever else he could get to play the market. He turned $500,000 into $2.5 million. But rather than stop there, he's still playing. People sometimes just don't know when it's a good time to stop, because they think it's always going to be a good time."

Among savers, the largest share are saving for retirement - a figure that has grown from just 20 percent in 1989 to 35 percent in 1998. "People are saving more for retirement than before," says Ellen Breslow, director of individual retirement planning for Salomon Smith Barney. "The change in tax laws in 1994, making some forms of IRAs tax-deferred or tax-sheltered, prompted more retirement savings. And since then, people have made an effort to become better educated about retirement planning."

Saving for retirement is not confined to older Americans, says Breslow. "Generation Xers are saving at a greater pace than boomers did when they were that age. There is a focus on starting to save earlier, and many of the younger savers are very conservative and very focused in their retirement savings planning."

But even retirement savings are not guaranteed against a market downturn or recession. "The change from defined-benefit pension contributions, in which the employer guaranteed a certain return on retirement investment, to defined contribution, in which the onus for return on retirement investment shifted to the employee, has made the future a little more uncertain for a lot of Americans," says Capital College's De Rooy. "While there has been no sustained economic weakness yet, a recession would quickly demonstrate the problem."

Apparently, many people sense the lurking danger. Despite media reports of a consumer spending spree, in fact Americans are spending cautiously, having learned a lesson from the recession of the early 1990s.

During that recession, the average household cut its spending sharply. We're still playing catch-up. The average household spent $35,535 in 1998, according to the Bureau of Labor Statistics' 1998 Consumer Expenditure Survey, the latest data available. That's 0.4 percent less than it spent a decade earlier in 1988, after adjusting for inflation.

This frugality helps explain why inflation remains under control. It suggests that households are investing for the long term, and that most are insulated from a market downturn. Even if things turn sour, they can wait to cash in their chips. They can postpone retirement for a few years. They can send their children to a public university rather than a more expensive private school.

The bottom line is this: The record affluence of the 1990s appears to be a tide lifting many boats and ferrying them toward a more comfortable future.

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