Adventures with the new plutocracy, wealth-beta edition

By Felix Salmon
December 19, 2011
Robert Frank -- the WSJ writer, not the Cornell economist -- had a fascinating column about what he calls "wealth beta" this weekend.

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Robert Frank — the WSJ writer, not the Cornell economist — had a fascinating column about what he calls “wealth beta” this weekend. If you’re a member of the 1%, it turns out, you don’t just have a lot of money; you’re also likely to be seeing a huge amount of volatility in your wealth and your income. And this volatility has been measured according to the familiar scale where the broad stock market has a beta of 1:

The new rich have become the high-betas of our economy. With their dependence on financial markets, their leverage and their hyperspending, the top 1% have income swings that now are more than twice as high as those of the rest of the population.

A study by Jonathan A. Parker and Annette Vissing-Jorgensen of Northwestern University found that the beta of the top 1% nearly quadrupled between 1982 and 2007 to 2.39. The top 0.01% had a beta of 3.96, making even the riskiest tech stocks look safe by comparison. Economists and wealth managers say the betas of the rich have likely soared even higher in recent months as markets gyrated sharply.

Frank’s column is based pretty unquestioningly on the idea that this is a bad thing, and he quotes a few wealth-management executives talking about how very rich people can stay rich for decades, and avoid losing all their money.

But my feeling is that high-beta wealth is something to be celebrated — it’s one of the few silver linings to the current rise in inequality. People might become stupendously wealthy, but we’re not really creating a new class of dynasts here. Instead, the money comes, and then, almost as fast as it came, it goes.

One reason is just that the idea of preserving wealth in one’s own family for many generations to come has rather gone out of fashion. If you inherit a fortune which has been in your family for hundreds of years, then you do generally feel a responsibility for maintaining it and passing it on to future generations. But families are smaller now than they used to be, and self-made billionaires don’t necessarily consider multi-generational wealth preservation as a particularly top priority. Indeed, it’s more common to see billionaires swing the other way: Warren Buffett, for instance, likes to say that he wants to leave his children “enough money so that they would feel they could do anything, but not so much that they could do nothing”.

And some billionaires, of course, are childless, which means they can and should do exactly what they want with their money. They’re basically forced to give it away to charity, since it’s pretty much impossible to spend that kind of money.

The fact is that if you’re hugely wealthy, you’ll almost certainly live very well for the rest of your life no matter how much of your money you risk and lose. Short of going to jail, the rich very rarely find themselves completely impoverished. And in any case, self-made plutocrats tend to have extremely healthy egos: they’re confident that if they lose everything, they’d be able to pick themselves up by their bootstraps and do it all over again.

Wealth, at these stratospheric levels, is a way of measuring who’s winning the game; if it’s not rising, you’re not winning. And of course the things that Frank prescribes — like taking on less debt and diversifying your holdings — tend to go directly against the very strategies which created all that wealth in the first place.

We live in a world where millions of people are pursuing dreams and careers which have some small chance of being hugely successful. The number of people who have a chance of achieving such success has never been greater — and when it arrives, that success is increasingly lucrative for those who get there. That’s the game; its winners change from year to year and decade to decade. But the glory goes only to the person who makes the money, not to anybody who inherits it — unless they, too, display a similar knack.

So let’s not encourage the uber-wealthy to squirrel away their money and keep it in their families. It’s a good thing that today’s wealth has high velocity and that if it doesn’t get lost in the marketplace it’s more likely than ever to end up somewhere philanthropic. Even if that frustrates executives at private banks and wealth management companies.

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Comments
21 comments so far

I think this column (and hence your analysis) are conflating two ideas: 1) high income volatility and 2) high wealth volatility. There are a few anecdotal pieces of evidence for number two, and the citation of one single Forbes 400 comparison, but the actual academic study refers to income. And, there I think, this volatility IS a bad thing for the rest of us; I doubt that it’s a coincidence that 1% income volatility and inequality have both been rising over the same time period.

Posted by MitchW | Report as abusive

I thought the column seemed to be taking a weird pride in the fact that rich people’s wealth is more pro-cyclical than that of the 99%.

Posted by dWj | Report as abusive

Are you sure that this vast possibility of success “has never been greater?” Most studies I have read indicate that moves up the economic ladder have decreased in the USA.

Posted by Chris08 | Report as abusive

Are you sure that this vast possibility of success “has never been greater?” Most studies I have read indicate that moves up the economic ladder have decreased in the USA.

Posted by Chris08 | Report as abusive

Felix – I think you have an overly charitable take on the data. I would like to see some data on whether the current 1% are giving more to charity than other generations.

An equally plausable story is that the extreme wealthy have more money than they can spend, so they gamble – er – “invest” it in an increasingly volatile global investment market, and it becomes part of that “big pool of money” sloshing around the world looking for return. Income comes less from some steady, productive building of businesses, and more from volitile hedge-funds and financial investments.

One would need to decompose the sources of income from the 1% to test which story really holds, but I think the fact that 40% of corporate profits are in finance is an indicator.

Posted by Ragweed | Report as abusive

“Wealth, at these stratospheric levels, is a way of measuring who’s winning the game.”

Probably true — but people who are NOT uber-wealthy often have other motivations that take precedence over raw greed.

Ironic that the people who need it the least also value it the most.

Posted by TFF | Report as abusive

It was pretty much the only intelligent/interesting thing Taleb ever came up with was the path-integral approach to measuring how wealthy someone was. A rather more pithy approach than the reporters…

Posted by Danny_Black | Report as abusive

“I think the fact that 40% of corporate profits are in finance is an indicator.”

Citation, please, Ragweed? Thought it had fallen from those levels.

Posted by TFF | Report as abusive

Giving money to charity is not necessarily recycling of that money, Felix. Just look at the Getty fortune given to the Getty museum and how by being forced to buy stuff every year, and having so much money to do it with, the money is distorting Art markets and concentrating ownership in a single place which is not in the interests of anyone.

Modern Billionaires could take a leaf out of the books of the Victorians: their bequests created hospitals, libraries, Universities (OK, that still happens to some degree) and other institutions that promoted the common good. It also seems strange that when poverty in the US and UK is in double figures, Billionaires such as Bill Gates give money to Africa – a laudable cause, but probably dispersed less well than an NGO would be able to do…

Posted by FifthDecade | Report as abusive

“It also seems strange that when poverty in the US and UK is in double figures.”

Poverty in the US is still miles better than the median in Africa. Really no comparison.

Money alone won’t solve either problem. But far more money is thrown at poverty in the US (admittedly much of it through the government) than at poverty in Africa.

Posted by TFF | Report as abusive

I think the ‘dynastic’ inequality locks in at a relatively modest level of wealth from the .01% vantage point. When you have home/s in the best sections with best schools and you kids get top-flite private school and college. That doesn’t take Gatesian wealth, but it’s a large factor in the growing distance between the mid-range and the top range in US, and the steadily decreasing mobility up.

Posted by crmorris | Report as abusive

“Poverty in the US is still miles better than the median in Africa. Really no comparison.”
-TFF

The difference is the median income in Africa allows a higher relative comfort of life than poverty in the US: how do you measure subsistence farming? It has no Western financial value at all, yet it feeds families. Those families already have the benefit of UNESCO and WHO programs, and many diseases are already defeated or on the way to be. In the US there are people suffering far more squalor by US standards than those families are in Africa by their standards. If the richest country in the world could manage its finances better there would be no poverty there.

Much of the poverty in Africa comes from the tribal system and the habit of the European Colonial powers splitting up a tribe’s area and people between them in a divide and rule strategy. Once colonialism collapsed, tribal loyalties returned, which is why democracy has such a hard time being adhered to. You then have two tribes in the same country with one dominant over another, and yet speaking the same language while members of the same tribes in different countries speak different languages.

Tribalism as a system (as in Saudi Arabia for instance) works through the feudal system of patronage, which we in the West call nepotism, or sometimes corruption. Old enmities are settled in places like Zimbabwe where the Matabele were split up into parts now living in Botswana, Zimbabwe and South Africa, while the Shona are dominant under Mugabe in Zimbabwe, but split up into parts now living in that country as well as South Africa, Zambia and Mozambique. This also explains the problems in Rwanda, Bahrain, Congo, Sudan and many other trouble spots.

The chief keeps the riches, and if you follow him you share in them, if you don’t you starve, hence the problems in Zimbabwe today. So even if you give lots of money to the poor of Africa, it goes to the rich anyway because they want the poor to be poor as a punishment. One could say that is how the rich of the West think of the poor of the West too, and perhaps your lack of sympathy for those in poverty in your own country aligns you with the feudal way of thinking. Love thy neighbour as thyself doesn’t come into it.

That’s not to say there aren’t people in Africa who don’t deserve help, but famines have always been part of African life, and are very often traced back to tribal differences eg Biafra in Nigeria in the 60s and Ethiopia v Eritrea in the 80s. Famine relief is a good thing, but as the old saying goes “Give a man a fish and you can feed him for a day; teach him how to fish and feed him for a lifetime.”
http://www.youtube.com/watch?v=Md4Su1RwL AY

I never did understand why the World Bank refused to lend money in the 70s/80s unless African countries charged kids to go to school. If any place in the world needs more education, it’s Africa, and if anywhere can afford it least, it’s Africa, and without education no development, democracy or change will come.

Posted by FifthDecade | Report as abusive

“In the US there are people suffering far more squalor by US standards than those families are in Africa by their standards.”

Yes, different standards. That is my point.

“So even if you give lots of money to the poor of Africa, it goes to the rich anyway because they want the poor to be poor as a punishment.”

Right. Gifts of money are not (by themselves) the answer when the structure of society is driving the problems. That is even more true in Africa than here in the US.

“perhaps your lack of sympathy for those in poverty in your own country aligns you with the feudal way of thinking”

EXCUSE ME?!?! I spend my days working with inner city students, many below the poverty line. Do YOU do anything to make a difference? Aside from copping a holier-than-thou attitude on blogs?

But believe me, my students don’t want to live in Africa. They don’t want to return to Haiti. They don’t want to live in a society dominated by tribalism. They want to stay here, work hard, learn the skills necessary to make good lives for themselves HERE. I guess you would say the problem is that their standards are too high?

Posted by TFF | Report as abusive

You’re talking about refugees, I’m talking about populations that continue to live in their home countries. Of course the refugees in the US want to stay there, they don’t want to be tortured or shot! Don’t believe everybody not in the US wants to get into the US; they don’t.

As for not wanting to live in a society dominated by tribalism, aren’t the 1% in the US rather tribal? You have the Gettys, the Rockefellers, the Kennedys, the Bushs, the Fords, the Murdochs and so on. There are also many local family dynasties in some of (particularly) the Southern US where there is still persecution against African Americans – and I suspect some of the Tea Party obsession with not letting Obama make progress is based on his ‘wrong background’ but that’s another story.

On charity, I don’t believe it should be an either/or choice, but I do believe in what Andrew Carnegie believed, that “the wealthy have a moral obligation to engage in philanthropy”. To put Carnegie’s work in perspective, he built and stocked over 2,500 libraries in the English speaking world. That’s quite a feat of philanthropy – has anyone matched it since (and that’s not counting the seven philanthropic and educational organizations in the US and more in Europe he created and endowed).

Posted by FifthDecade | Report as abusive

“People might become stupendously wealthy, but we’re not really creating a new class of dynasts here” Of the 10 richest Americans 4 bear the name Walton and 2 the name Koch. Are these very frequent names in the US or are these persons related ?

Posted by hansrudolf | Report as abusive

“I do believe in what Andrew Carnegie believed, that “the wealthy have a moral obligation to engage in philanthropy”.”

As do I. (And I am puzzled by Felix’ seeming assertion otherwise. I believe he is also confusing “alpha” and “beta” in the income/wealth charts.) But money alone won’t cure these ills, not here in the US, and not in Africa either. It is also essential to have people giving their efforts to addressing the problems. There is no money in serving the poor, but it will make you rich.

Posted by TFF | Report as abusive

I agree with that, TFF, but one of the points I think too many people miss is that for a business, an ad hoc development of following what customers can be persuaded to buy is not a good model for charitable distributions of wealth IMO.

If a country’s main source of revenue for the needy comes from select individuals with surplus billions, you end up with a kind of “Trophy Charity” system which supports the ‘sexy’ ideas and leaves the messy ones unfunded. That is why you need at least some State involvement where the government acts as coordinator and ensures that all needs are treated pretty much equally, as far as possible.

Is that an argument for a welfare state as is found in nearly all European countries? Perhaps so, but it sounds more like common sense to me.

Posted by FifthDecade | Report as abusive

“…you end up with a kind of “Trophy Charity” system which supports the ‘sexy’ ideas and leaves the messy ones unfunded.”

Absolutely! It is easy for my school to get grant funding for a “sexy” idea, such as a field trip or a dozen new computers for a lab. But trying to fund the teachers who make the school *succeed* is a perpetual challenge. (Admittedly also an order of magnitude more expensive — perhaps $30k or $40k per full-time position.)

Government controls greater flows of money and thus is a better source of funding for these “core” needs.

Posted by TFF | Report as abusive

“One reason is just that the idea of preserving wealth in one’s own family for many generations to come has rather gone out of fashion.”

What color is the Sun on your planet, Felix? Or have you forgotten that LTCM (for instance) blew up in part because they gave investors their money back, having bought into their own hype and thought they “were on the brink of amassing dynastic fortunes” (Lowenstein, p. 120).

Yes, The Kids often make attempts to cash out–see the Mars family or the Rooneys, for example–and the generations multiply, but the idea of “preserving wealth in one’s own family” doesn’t go away.

Posted by klhoughton | Report as abusive

Talking about LTCM and dividend payouts, there are two things that companies about to fail are reputed to do:

1) Build a new, sexy Headquarters building;
2) Start paying dividends.

Currently Apple is doing the first and rumoured to be about to do the second. When Microsoft started paying out dividends, it was the beginning of a long fallow period with little or no growth in share price, and compared to Apple its performance has been lacklustre to say the least. Apple\s situation does concern me, but as I have no Apple stock it’s just a worry about continuity of supply for their great products.

Posted by FifthDecade | Report as abusive

Wouldn’t we expect the income of the top 1% to be extremely volatile because at higher income levels recognizing income is to some degree a voluntary act?

Many mechanisms for creating great wealth rely on creating assets of value. As such, there is no income realized until one chooses to do so.

Those pre-IPO Facebook shares don’t generate any income until they are actually sold.

Posted by clf | Report as abusive
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