How Long Is the Way Out of the Hole?

The stock market just ended its worst week in history. This has sharply eroded families’ financial security. Under rather optimistic expectations it would take about six years before families can hope to achieve the same level of financial security as they had at the end of 2007, before the latest round in the financial market crisis took shape.

Often observers will look at how long it took a stock price index after past crises to recover its previous nominal level. This approach has several problems, though. It understates the speed of recovery since it tends to ignore the fact that stock holders will also earn a dividend on their stocks and generally reinvest that dividend, especially if the money is invested in an index fund in a retirement account, such as a 401(k). It also tends to understate the speed of financial recovery for families since most families hold bonds in addition to stocks. So, the drop in stock prices overstates the actual drop in people’s portfolios. Looking just at stock prices will, however, overstate the speed of recovery in financial security since it ignores that incomes also rise at the same time—after all wealth exists primarily as an income replacement measure.

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