US Inequality is Feeding on Itself

The fact that the richest Americans are grabbing such a big slice of the pie isn’t exactly breaking news.

What is news is that Wall Street is getting nervous about it. Moody’s Investors Service, a private watchdog for the federal government’s fiscal soundness, has concluded that inequality has reached the point that it threatens a system already being strained by increases in the federal debt. But Moody’s also noted that inequality is contributing to slower economic growth, which further aggravates inequality.

The high level of U.S. inequality today “sets us apart” from Canada, Australia, and several European countries, Moody’s said in an October report, “Widening Income Inequality Will Weigh on U.S. Credit Profile.”

Moody’s central concern is how inequality will affect the federal budget. When the economy slows in periods of high inequality, there are more lower-income households requiring support from costly programs like Medicaid.  Federal tax revenues also decline during any downturn, leaving less money to pay for these means-tested programs and for social insurance programs like Social Security and Medicare.

The firm’s second concern is that inequality is a drag on the economy. When the middle-class is squeezed, for example, they have less money to buy consumer goods. And when the economy slows down, inequality can increase, as it did in the years after the 2008-2009 recession.

This has played out in a widening wealth gap, Moody’s said.  The typical lower and middle-income worker’s net worth – assets minus liabilities – has shrunk since the recession, while net worth rose sharply for the people at the top.

One big reason for widening inequality is the stock market. Even though the market declined sharply this month, the post-recession bull market has beefed up investment portfolios – but only for the 50 percent of Americans who own company shares or stock mutual funds.

A second contribution to a widening wealth gap, post-recession, has been housing. A home is often the most valuable asset people own, so the steep drop in house prices and the spike in foreclosures were big setbacks for people who aspired to build wealth through homeownership.

According to a recent Federal Reserve study, millions of first-time homebuyers, particularly blacks and Latinos, who took out fraudulent subprime mortgages lost not only their homes in foreclosure but the savings they used for down payments.

Contrast that to high-income and wealthy people who could afford to hold on to their properties as values plunged and then rebounded in the strong housing market, especially in the cities.

Inequality is also feeding on itself through an important avenue that low- and middle-income families have always used to improve their children’s prospects – by sending them to college.

A 50 percent increase in college costs in 15 years, combined with the necessity to borrow large sums to pay for it, will close off opportunity for more and more lower-income families, Moody’s said.  This outcome would reinforce the existing mismatch between less-educated workers and the good jobs available in a modern economy requiring a college education – a mismatch at the heart of today’s inequality.

The economic expansion continues, yet six in 10 people surveyed in a recent Harris-Harvard Poll said their personal financial situation is no better or worse than it was a year ago.  Widening U.S. inequality may partly explain why.

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