Why the Richest Americans Could Be Set Up for Disaster
Sep 14th 2013 3:00PM
Updated Sep 14th 2013 3:04PM
Let's face it: We'd all like to own a private jet, get driven around by chauffeurs in rare automobiles, eat at the priciest restaurants, and in essence never worry about money again. I'd speculate for more than 99% of us, this is just an aspiration, but for some of the wealthiest Americans in the United States, this is their everyday life.
A common misconception about the rich is that many were born into wealth. On the contrary, many of the wealthiest individuals in the world -- or at least the ones most commonly in the spotlight -- have earned their fortune, including Berkshire Hathaway's CEO Warren Buffett, who, through disciplined investing, has built his company into the 58-subsidiary-strong conglomerate that it is today. Facebook CEO Mark Zuckerberg is another prime example of a self-made billionaire, building Facebook from the ground up through partnerships and hard work. In short, it may not seem fair for someone to possess such a disproportionate amount of money relative to the average working-class citizen, but in more cases than not, they've earned it through hard work and/or smart investments.
However, according to a report out earlier this week by The New York Times, that disproportionate wealth relative to the working class may be at far greater risk than many of the richest Americans realize.
Surprise, surprise: The rich got richer
According to The New York Times' report, three factors have contributed to a surge in income among the United States' wealthiest individuals. First, a gigantic rebound in the stock market from its March 2009 lows have boosted the overall wealth of America's richest individuals. Just for comparative purposes, the Dow Jones Industrial Average and broad-based S&P 500 have bounced 134% and 149%, respectively, since their lows four and a half years ago. As of 2011, the top 1% of income earners in America owned about half of the United States' stocks, bonds, and mutual funds, as compared with the bottom 50% of Americans, whp own just 0.5% of these investments. Expanding that even further, the top 10% of households own 90% of all stocks in the United States! As the markets continue to march higher, so does the wealth of our nation's top income earners.
The second source of growing income for the United States' wealthiest individuals is real estate. Home prices are on the rebound thanks to rapidly shrinking new and foreclosed housing inventories and historically low lending rates, which have spurred new home buying as well as investment-oriented borrowing and purchasing. According to Forbes in 2012, of the then 425 worldwide billionaires, 27 of them were made because of real estate investments. As of the latest Case-Shiller Index report, which is a measure of home prices in 20 of the United States' largest cities, home prices between June 2012 and June 2013 had risen by 12.1%, putting a good chunk of change directly into the pockets of the United States' richest individuals.
Finally, favorable tax code helped out the rich in 2012, with the U.S. government deciding not to roll back all of the Bush-era tax cuts on the wealthy. This isn't to say that the United States' wealthiest individuals aren't paying their fair share so much as it points out that they aren't paying nearly as much as everyone expects they should.
Added together, these three factors allowed the top 1% of income earners to accumulate 22.5% of all U.S. income in 2012, with the more expansive top 10% of income earners accounting for better than 50% of all income last year -- the highest level in 100 years of record-keeping. To put it another way, the rich just keep getting richer.
But that trend looks as if it could come to a grinding halt. Here's why.
The coming disaster for America's wealthiest individuals
For one, with the wealthiest individuals controlling a vast majority of stock, bond, and mutual fund investments in this country, they're at the greatest risk of wealth depreciation if the U.S. economy stalls. Given this week's initial jobless claims figure, which came in at a seven-year low, that might seem highly unlikely, but I'd beg to differ.
It's been my stance all along that the Dow and S&P 500 are rallying, but for all the wrong reasons. One in particular has been an improving jobs market.
I certainly can't deny that unemployment has been on a steady decline for years now, which you have to think would bode well for consumer spending and worker productivity. The reality is that in 2013 about three-quarters of jobs created have been part-time in nature. Whether it's from the upcoming implementation of the Patient Protection and Affordable Care Act, also known as Obamacare, which has corporations cutting workers' hours to free themselves from any chance of being penalized for not providing health-insurance options to its full-time employees, or simply tight corporate wallets, the labor picture isn't as sound as it appears.
The labor force participation rate at a new 35-year low should also be a concern for all investors.
Some people do drop out of the workforce to go back to college or retire, but I have to believe we're still a long way away from seeing a big baby boomer-induced retirement surge. Instead, I'd propose that with the majority of jobs available being part-time in nature and the median unemployment stint still ranging close to 37 weeks, unemployed workers are simply too discouraged to keep looking for work and are dropping out of the labor force participation calculation.
The housing market isn't in any better shape
Another concern that wealthy investors have to have front and center is what will happen to the Dow and S&P 500, as well as the housing sector, once the Federal Reserve begins to pare back its monthly bond-buying program known as QE3. This easy money program has been largely credited with keeping lending rates at historic lows and buoying a struggling housing industry.
However, once QE3 begins to be wound down, there's a strong possibility that lending rates may reverse a multi-decade downtrend and head higher. Ever since the Fed hinted at the possibility of tapering QE3 back in early May, 30-year mortgage rates have risen by roughly 120 basis points, and mortgage applications, which include refinancing and new home loans, have fallen by a whopping 59%! The American consumer has been spoiled with years of low lending rates and simply isn't going to bite in great numbers at a rate of 4.5% or higher on a 30-year mortgage, even though we're still well below the historical average.
If you think I'm making a big fuss about nothing, then just look at the recent layoffs in the mortgage divisions at some of our nation's largest banks for confirmation of this trend. Bank of America announced earlier this week that it plans to lay off 2,100 people from its mortgage division as higher interest rates crush refinancing activity. But B of A isn't alone. Wells Fargo announced last month that it, too, will jettison 2,300 mortgage segment jobs in lieu of slowing originations activity.
Home prices may be going up at the moment, but if no one is purchasing homes or refinancing existing homes, banks and the housing sector could be in trouble fairly quickly no matter how tightly the homebuilding industry controls its inventory.
The taxman will cometh
In 2012, the United States' wealthiest individuals enjoyed numerous tax breaks. Beginning this year and moving forward, they won't have nearly the same luxury.
Obamacare, for instance, adds extra taxation on upper-income earners to help pay for the upcoming Medicaid expansion that will bring insurance to some 16 million currently uninsured individuals over the next decade. This will be accomplished by a 3.8% tax on investment and dividend income for individuals who earn more than $200,000 in adjusted-gross income in a year (or married couples with more than $250,000 in AGI). There is also a 0.9% health-care tax on upper income earners.
Other tax-code changes that have been employed include a higher tax on dividends for upper-income earners (20% as opposed to 15%), and a sizable bump in personal income tax for the nation's wealthiest individuals to as high as 39.6%! Higher taxes are bound to take a bite out of these individuals' pocketbooks.
It could happen again
During the recession, the top 1% saw their incomes plunge by 36%, while the remaining 99% saw their incomes dip by just 12%. The difference has been that, since the recession, the top 1% have seen their incomes rise by 31%, compared with a paltry 1% gain for the remaining 99%! It's quite possible that the rich could be again on the precipice of a major decline in income. Obviously it would take all of the factors I've mentioned for this to happen, but the ideas I propose aren't as far-fetched as you might surmise. With their wealth concentrated in the U.S. stock market and in real estate, it wouldn't take a huge decline to have a big impact on the pocketbooks of the United States' wealthiest individuals.
The article Why the Richest Americans Could Be Set Up for Disaster originally appeared on Fool.com.Fool contributor Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong . The Motley Fool owns shares of, and recommends, Bank of America, Berkshire Hathaway, Facebook, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.