The High-Beta Rich: How the Manic Wealthy Will Take Us to the Next Boom, Bubble, and Bust Review

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The High-Beta Rich: How the Manic Wealthy Will Take Us to the Next Boom, Bubble, and Bust ReviewThis is an excellent book about a little known subject: Plutonomy. The Plutonomy theory was advanced in 2005 by three Citigroup stock analysts, including Ajay Kapur mentioned in the book. Their research report was called "Plutonomy: Buying Luxury, Explaining Global Imbalances." This theory was so controversial that Citigroup removed it from its website. The main point is that the rich (typically defined as the top 1% of earners) control a very large and rising share of national consumer spending. Mark Zandi, the chief economist for Moody's Analytics uncovered that the top 5% of American earners account for 37% of consumer spending (up from 25% in 1990). This same group has also the lowest savings rate at 1.4% vs 8% for the rest of Americans. Therefore, their spending habits have a disproportionate impact on the overall economy including our savings rate and related Current Account Deficit.
Robert Frank advances the Plutonomy theory further by tying Ajay Kapur's work with the working paper of two Northwestern University economists, Jonathan A. Parker and Annette Vissing-Jorgensen titled "The Increase in Income Cyclicality of High-Income Households..." Fusing those two works, Robert Frank states that since 1982 the rich have become risk takers and gamblers. This is because starting in 1982 government policies have favored risk taking by lowering interest rates, inflation, and taxes, and deregulating the financial markets. The combination of those policies contributed to an excessive extension of real estate credit and a succession of real estate and stock market bubbles caused in part by the High-Beta Rich exploiting the mentioned government policies.
One of the most powerful insights from this book is that the High-Beta Rich are very vulnerable and associated with a rapid turnover among their ranks. Among the top 1% of American earners (income > $380,000), only half made the cut more than once over a ten-year period (pg. 217). Frank also shows two charts early in the book that compare the gains and losses in income of the top 1% in the U.S. vs all taxpayers. Before 1982, the fate of both groups was similar. Then, after 1982 the two groups diverged radically. Whether up or down, the changes for the top 1% became a high multiple vs the norm. The top 1% boosted their income a lot more during expansions. But, their loss was also far greater during contractions. This is because the High-Beta Rich have a surprisingly low savings rate and are very leveraged. Their leverage does multiply both their gains and their losses. The mentioned economists uncovered that before 1982, the top 1% had a Beta of less than 1 (meaning they took less risk than the general population and their fortune was less volatile). But, after 1982 their Beta jumped to between 2 and 3 as they took on far more risk than the general population. Their high Beta is due to a greater concentration of their wealth in volatile assets such as stocks and real estate and a greater leverage.

The High-Beta Rich volatile income causes chronic Budget Deficits at all levels. In California the top 1% of earners were paying 41% of taxes during the dot.com boom in the late 90s. Capital gains taxes accounted for a large share of tax receipts. When the dot.com Bubble burst California tax revenues tanked and it experienced chronic State Budget deficit crises in the early 2000s. However, by 2007 the top 1% of earners were accounting for an even greater share of CA State tax receipts at 48% (nearly half!). This was due to a recovery in the stock market (capital gains tax) and the housing boom (property tax). The ensuing financial crisis caused the rich income to drop by three times as much as the general population (Beta of 3). By 2011 California tax revenues cratered associated with a $26 billion budget hole. The same is true for New Jersey, New York, and Connecticut with many High-Beta Rich. It is true at the Federal level as the top 1% earners pay more than 38% of federal income taxes.
Frank states that the financial behavior of the High-Beta Rich contributes to exacerbating business cycles with more bubbles and ensuing crashes of greater magnitude and greater frequency than otherwise. Large concentration of wealth may be both a cause and effect of bubbles. Speculative asset bubbles correspond to periods of highest inequality. By 2007, the US top 1% controlled 34% of the nation's residential real estate. Between 1989 and 2007, they increased their relative exposure to real estate by 50% by quadrupling their mortgage debt level over the same period.
If you want to further study the impact of deleveraging, the best book on the subject is Irving Fisher The Debt-Deflation Theory of Great Depressions. Originally published in 1933, it also better explains the current financial crisis than most current books.
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