- UK's household wealth dropped due to rising interest rates, with regions like Scotland hit hardest.
- The US faces a similar risk with many Americans' wealth tied up in home equity and retirement accounts.
Household wealth in the UK has fallen sharply over the last two years in part thanks to high interest rates, and the factors that led to the drop suggest a similar scenario could be heading for the US.
New research from the think tank Resolution Foundation found that median household wealth in the UK fell 21% from the start of 2022 through the third quarter of 2023, representing a loss of £2.2 trillion (US$2.7 trillion).
The fall is due, in large part, to the large percentage of wealth tied up in home values and pension accounts — a recipe also seen in the US — and how both are susceptible to the ripple effects of interest rate hikes.
Pensions have been hit the hardest so far
In the UK, about 80% of all household wealth is held in home equity and pension plans, and both had surged over the last 40 years.
Pensions have been hit the hardest so far by the sharp rise in interest rates from the Bank of England, according to the research, although the fall in property wealth has also contributed.
That's because pension pots in the UK are heavily invested in government bonds. As bond investors demand higher interest rates — the 10-year UK bond is now above 4.5% — the price and thus market value of those bonds drops.
While Resolution Foundation found a significant drop in wealth since the Bank of England started hiking rates in late 2021, the decline varied by region.
Scotland, Wales, and the North of England had the biggest drops of 24% to 26% in total household wealth. These areas tend to have lower house values and more of their net worth in pensions.
Meanwhile, the South and East of England have seen a drop in net worth of 19%. The smaller decline is due to more value being tied up in real estate.
Home values have contributed to the overall drop in household wealth, but they are yet to fall significantly in the face of high interest rates.
The Resolution Foundation authors did offer a dire warning that the slight buffer seen in housing values might only be temporary if prices do start to succumb to high mortgage rates. If so, the level of total wealth depleted by falling home equity could rise to a level similar to that of the drop in pension wealth.
Similar factors are seen in the US
The factors leading to declining household wealth in the UK cast a long shadow over the US. Like the UK, a large portion of US net worth is tied up in real estate and retirement plans.
According to the US Federal Reserve's Survey of Consumer Finances, in 2022, 75.2% of household assets were in retirement accounts and home equity.
US pension funds are major holders of US Treasury securities, and like the UK, Treasury yields have surged, with the 10-year bond briefly topping 5% a week ago. This was after the world's top 300 retirement funds fell 12.9% in 2022, the worst decline since the financial crisis of 2008. However, most top funds rebounded in the first half of 2023.
Meanwhile, the researchers noted that home equity value has not been hit as hard yet as pensions in parts of the UK where housing prices have been resistant to drop. We have seen the same scenario play out in the US.
US home prices have stayed high this year thanks to the same high interest rates. Homeowners locked into significantly lower rates have been reluctant to sell their houses unless necessary. This decreased the supply of homes for sale and kept prices rising.
But now some analysts are predicting housing values to plummet as much as 30% in the near future, including Jeremy Grantham, co-founder and chief investment strategist of GMO.
"House prices will come down," Grantham said on "The Compound and Friends" podcast. "30% would be a pretty good guess."
Daniel Bustamante, the founder and CIO of the Bustamante & Co. hedge fund, told Insider earlier this month that he is predicting home prices will fall 15-20%. He called that estimate "conservative," noting that there is growing pressure on the American consumer and more people will be forced to sell houses to pay their bills.
Lower prices are good news for buyers, but it would also destroy a lot of home equity and net worth for Americans.
Things will likely get worse
Policymakers in both the US and the UK are expected to hold interest rates at their current levels for now and keep them elevated well into 2024. However, the higher-for-longer scenario could continue to eat at household wealth.
High interest rates are already hurting pension values, which will likely continue. If mortgage rates eventually pull housing values down, as expected, the household wealth problem grows.
The Resolution Foundation's authors warned that this would be especially troublesome in all areas of the UK but for differing reasons.
In Scotland, Wales, and North of England, home values are already lower, and they are at greater risk of falling into negative equity, where the amount owed on the mortgage is greater than the house's value. Meanwhile, the South and East of England have more wealth tied to real estate and will lose more total value if the real estate market crashes.
In the US, we could also see different impacts on various groups, especially across generations. Baby boomers, for example, have much more money tied up in pensions and real estate than younger generations.
Not only would their net worth get damaged significantly by a drop in home values, but that could lead them to reel in their spending, which has helped keep the US economy afloat.
In other words, this looming bust in net worth would likely be the start, and other problems will follow.