$6 Trillion Down, $33 Trillion To Go

US households saw their net worth decline by more than $6 trillion in just three months during the second quarter. In absolute terms, it was the single largest one-quarter wealth shock in American history.

Fed data released Friday showed household wealth in the US dropped by $6.099 trillion during the period, as losses tied to a bear market in stocks more than offset another blockbuster quarter for property prices.

The decline eclipsed the wipeout catalyzed by the onset of the pandemic (figure below), although when calculated as a percentage of the total at the time, the pandemic drop was larger.

Thanks to a record $1.7 trillion gain in real estate values during this year’s first quarter, overall household wealth barely retreated despite a near $3 trillion loss in Americans’ equity holdings. In Q2, by contrast, the depth of the stock rout easily overwhelmed gains seen across other assets.

The cumulative gain since the second quarter of 2020 was trimmed to “just” $33.43 trillion. The Fed now realizes that massive windfall contributed to inflation. Knowing they can’t solve supply chain problems, drill for oil, produce natural gas, grow wheat or mediate a ceasefire in Ukraine, policymakers believe taking back a portion of America’s accumulated wealth gains is among the most expedient ways to cool price growth.

Remember: The surge in household wealth worked on both sides of the equation. It helped drive up demand for goods and, later, services, but it almost contributed to early retirements, thereby exacerbating America’s labor shortage. Given the scope of the inflation overshoot and the extent to which mismatches in the labor market have the potential to embed a wage-price spiral in the economy, the Fed likely wants to destroy a meaningful portion of the pandemic wealth gains it helped facilitate.

If that’s true (and it most assuredly is) Q2 represented real progress. The value of household equities dropped a remarkable $7.72 trillion, more than the decline witnessed during the pandemic bear market (figure below).

In the first half of 2022, the value of Americans’ corporate equity holdings plunged by almost $10.7 trillion. At the peak late last year, the accumulated stock gains since Q2 2020 were around $23 trillion. As of June, they were $12 trillion.

The value of real estate logged another steep quarterly increase. The $1.4 trillion rise was the seventh consecutive quarterly gain of at least $1 trillion (figure below).

Although the pace of home price appreciation has slowed sharply, almost no one currently predicts a collapse, even if many are now belatedly on board with the idea that prices may decline nationwide, not just in select locales.

The Fed has repeatedly referenced the slowdown in housing market activity as evidence that rate hikes are cooling the economy. After a reprieve that accompanied a pull back in Treasury yields, mortgage rates are back to the highest levels seen since the financial crisis.

At this point, I’ve exhausted my capacity to paraphrase myself while documenting the Fed’s quarterly update on household wealth. Rather than try, I typically recycle a set of familiar talking points, on the way to citing a prescient passage from the incomparable Zoltan Pozsar who, in February, warned that the Fed would likely attempt a controlled demolition of household wealth gains.

Soaring stock and home prices minted countless American millionaires, even as the property boom put homeownership out of reach for countless millions of Americans. It’s now painfully obvious that showering money on homeowners and stockholders compelled a meaningful number of people to consider exiting the labor force — some of them permanently. At the same time, all that free money contributed to voracious demand for consumer goods, juxtaposed with a broken global supply chain.

Although it’s impossible to precisely quantify the Fed’s role in America’s inflation crisis, it’s not difficult to document the channel through which monetary largesse contributed. It wasn’t “money printing,” per se. The Fed didn’t send out checks totaling $40 trillion. Instead, they flooded the financial system with liquidity and binged on mortgage bonds, in what amounted to a Bernanke flex on steroids. The result is illustrated in the figure (above), which also gives you some additional context for Q2’s stock-inspired drop.

“If something indeed happened to the supply of labor post-pandemic (and some of that is wealth related), then to cool price pressures, maybe a pre-pandemic wealth level is appropriate indeed,” Pozsar famously speculated in May. A few months previous, he wrote that,

If the young feeling Bitcoin-rich are less inclined to work and the old feeling mass affluent are eager to retire early, labor force participation drops to the detriment of real growth prospects. Maybe the path to slower services inflation — OER and all other services — is through lower asset prices. Volatility is the best policeman of risk appetite and risk assets. To improve labor supply, the Fed might try to put volatility in its service to engineer a correction in house prices and risk assets — equities, credit and Bitcoin too.

In the same February note, Pozsar suggested that soon enough, “the Fed will incorporate some version of this thought process,” extreme though the prescription seemed at the time.

Ultimately, he was correct. If he was also correct to suggest the entirety of the pandemic wealth gains need to go, you owe Jerome Powell another $33.43 trillion. Even after handing back $6 trillion in Q2.