Back in May, I did a Q&A with University of Chicago economist Raghu Rajan, who argues that income inequality contributed to the financial crisis. Over the weekend, the NYT dove into that topic, highlighting the work of Harvard Business School's David Moss:
Mr. Moss said that income inequality might have complicated links to financial crises. For instance, inequality, by putting too much power in the hands of Wall Street titans, enables them to promote policies that benefit them "” like deregulation "” that could put the system in jeopardy. Inequality may also push people at the bottom of the ladder toward choices that put the financial system at risk, he said. And low-income homeowners could have better afforded their mortgages if not for the earnings gap.
I'm not sure that income inequality is the thing that puts too much power in the hands of Wall Street titans, but the idea that homebuyers inappropriately financed their homes is similar to what Rajan talks about.
The argument is that part of the reason we wound up with a ultra-low interest rates and lax lending and 0% down mortgages is because that's the only way people could afford to buy things and not feel as if they were slipping behind.
In the NYT piece, Glenn Hubbard is presented as having a different point of view: that policymakers inappropriately tried to address income inequality by boosting homeownership when they should have instead been focused on education"”the thing that ultimately leads to more desirable workers and higher wages.
I'm not sure that's as different a perspective as it's made out to be. I think Hubbard is just being explicit about how income inequality translates into easy credit. Policymakers are under pressure to make members of the middle class feel richer even though, relatively speaking, they aren't. Helping consumers borrow more in order to finance their consumption is the simplest way to get there.
The alternative, Hubbard says, is to improve education. Although, as Rajan noted in our conversation earlier this year, "education" isn't just about schooling. It's also about the priorities and actions of families and communities. This is a country that often idealizes the jock before the nerd, one that has been known to interpret intelligence as putting on airs. Unfortunately, that doesn't get you good jobs or high incomes in a globalized economy.
Income inequality is a just buzzword for redistribution of wealth and is simply a way to conceal socialist goals. The concept used to be that if you studied hard, worked diligently, avoided drugs, avoided crime, avoided gangs, avoided single parenthood, stayed in school and saved your money you could, and would, do well in America. These concepts are still true today. But liberals are afraid of and cannot accept those ideas. The politically correct want us to believe that those who succeed do so only through luck, or theft, and therefore deserve to be plucked like chickens. That is a great concept if you want the communist state, but foolish if you want the country to succeed or any economic system to actually work. Are you still a liberal? Why?
Instead of blaming liberals and socialism lets look back at the big picture and see if we can agree. During both the Clinton era and the Bush era we enjoyed a good economy and jobs in most areas of the country, there didn't seem to be a great deal of differance between the two ignoring other factors. You no doubt are aware that factory jobs have been leaving the US for some 40 years or more. Equaling less better paying options for workers. But borrowing and buying homes and reselling for a profit was an excellant way to boost your earnings from your regular job or your perception of your situation. You borrowed and spend and the consumer is responsible for some 70% of gdp. So even though good jobs were leaving and cheaper paying service jobs emerged we didn't notice how bad things got because we were able to make money on real estate and spend. Of course we can't do that anymore and so here we are in the depression. What is the magic bullet to bring us out of the rut? No body knows, we can't go back to consumer spending until consumes can feel good about it, and they don't so here we sit until somebody comes up with the elusive fix. We are going to stay this way. So why can't we put behind us this liberal/conservative bashing it clouds the waters, and look for some real answers if there are any.
Thanks, Barbara. Good point about inappropriate financing, but don't forget the size of the homes and thus the mortgages in addition to subprime lenders' system gaming. Smaller homes / condos exist but bigger homes / McMansions were de rigueur for new homes during the cheap money boom "¦similar for cars too. Not now. If lenders everywhere had resisted greed (ha!) and nudged lower incomers away from mansions and towards smaller condos "“ with reasonable mortgages and honest, documented income verification "“ would there have been less damage? Good posts here, Barbara, more thoughts please.
Income inequality is not a buzzword. Its based on the premise that 20 years ago the average CEO earned about 25% more than his/her average worker, today a CEO makes 10 times that much. Executive pay has gone up and up while the average worker, when adjusted for inflation, actually earns less. This brings the standard of living for the working class--the factory workers, cleaning crews, secretaries and service industry personel to an all time low. . I earn about the same as my parents did when I was growing up. And while my parents were able to afford to keep a nice, three bedroom home, have 2 cars and pay for family vacations each summer; I have trouble paying the property taxes on the house my grandmother gave to me, to keep a single car on the road and budget for needed home repairs as they become necessary. And vacations? My last "vacation" was necessary to burn time off I'd built up or lose it. I sat at home for a week, watching tv and cleaning out closets. The idea of taking a trip is a foreign concept to many people today. I can't even afford to buy a fishing license.
How Inequality, Chinese Mercantilism, and Tax Cuts Created a Savings Glut Seeking Yield Causing a Debt Bubble Justified by a Housing Asset Bubble Leading to the Great Recession
Economists have described the causes of the great recession and the possible ways forward from a number of perspectives. One perspective that deserves more discussion is the concept of a savings glut that created pressures to seek yield. Viewing the great recession as arising from too much debt misses the other side of the coin, savings pressure seeking yield. The key is that borrowing has to equal savings. Three factors contributed to a large savings pool seeking returns. An (1) increased consumer savings pool partly arose from tax cuts which government had to replace with borrowing. The (2) financial system magnified savings through fractional banking. (3) Trading partner mercantile policies contributed diverted savings from emerging economies to the US. The following provides a simplified macroeconomic model of how wealth and income inequality contributed to this savings phenomenon and increased and contributed to causing the great recession.Macroeconomic analysis starts with four cohorts, consumers (C), businesses (B), government (G), and trading partners (F). To understand the following dynamic, consumers will be divided into two cohorts and businesses will be divided into two cohorts.
The two business cohorts are finance industry (Bf) and non-finance industry (Bn). Understanding the finance industry (Bf) cohort is critical. The finance industry (Bf) cohort is a conduit for matching savings and borrowing and a creator of an increasing level of funds for borrowing. Money is created by the Federal Reserve. Fractional banking magnifies the funds created. If bank reserve requirements are 10%, the fractional system provides an increase of $10 in loans for every $1 created by the Federal Reserve. The finance industry (Bf) cohort magnified Federal Reserve money creation even further by the creation of shadow banking units, some of which had reserves of about 3% creating $30+ dollars for every dollar of reserves.
For the consumer cohorts, approximate what happened by assuming a correlation between income level and savings. Stated simply assume low income consumers to be net borrowers and high income consumers to be net savers. Assume some percentage of consumers such as the lowest 90% in income borrow on net an amount equal to the net savings of the highest income 10% magnified through the finance industry (Bf). Whether 90% is the right number is not critical to the following discussion. The consumers cohorts are consumer borrowers (C90%) and consumer savers (C10%).
Some observations about the 2000s leading up to the great recession. Government (G) net borrowing was about equal to trading partners (F) net savings in the US. Savings by consumer savers (C10%) were about equal to borrowing by consumer borrowers (C90%) and are assumed to net to zero for the following discussion.
Here is a simplified description of what took place.
* Government (G) lowered taxes benefiting primarily the consumer savers (C10%) cohort. This increased the level of savings searching for investment. * Consumer borrowers (C90%) wanted to buy much of our trading partners (F) products and services. * For consumer borrowers (C90%) to buy these products and services, savings had to be made available to them. * As we well know now, the borrowing of consumer borrowers (C90%) greatly exceeded their ability to pay from current and expected income. * Savings was made available to consumer borrowers (C90%) through the finance industry (Bf) based on expected increases in new and existing home values used as collateral. * Trading partners (F) on net ran mercantile policies. The US trade deficit (and current account deficit) was financed by trading partners lending to us. In other words our trading partners (F) on net had dollars they wanted to save instead of spend.
* Savings flowed from consumer savers (C10%) and trading partners (F). * Non-finance businesses (Bn) were not major borrowers or savers. * Savings flowed to (i.e., borrowing was made) by consumer borrowers (C90%) and government (G). * The finance industry (Bf) was a conduit magnifying consumer savers (C10%) savings. Since the finance industry (Bf) is primarily owned by consumers savers (C10%), it can best be viewed as an extension of consumer savers (C10%). The growth of the finance industry (Bf) primarily benefited consumer savers (C10%) cohort contributing to wealth and income inequality. * High finance industry (Bf) wages and bonuses went primarily to people who were in the consumer savers (C10%) cohort further contributing to wealth and income inequality. * Trading partners (F) savings went primarily to fund government (G) debt. * Consumer savers (C10%) (including finance industry (Bf) created money) went primarily to consumer borrowers (C90%). * When home values ceased to provide collateral for consumer borrower (C90%) debt, consumer savers (C10%) and the finance industry (Bf) suffered the losses. The losses for consumer savers (C10%) were increased by the fact that this cohort was the primary owner of finance industry (Bf) equity and bonds.
What was the role of government deficits in this dynamic. If government (G) had not run deficits, consumer savers (C10%) would have had less savings and trading partners (F) would have had to make up the savings difference (or sell less) taking on consumer borrowers (C90%) credit risk. Trading partners (F) might have been less generous with credit terms. Even if the great recession still happened the risk would have been spread more broadly between beneficiaries of the boom, the consumer savers (C10%) and trading partners (F). Interestingly trading partners (F) savings placed in government (G) borrowing avoided the losses that consumer savers (C10%) suffered as result of placing savings through and having ownership interest in the finance industry (Bf).
"In the NYT piece, Glenn Hubbard is presented as having a different point of view: that policymakers inappropriately tried to address income inequality by boosting homeownership when they should have instead been focused on education"”the thing that ultimately leads to more desirable workers and higher wages" . I agree, and have discussed this idea at Salary for Attending School. . Most ideas regarding a cure for income inequality involve some version of the "Robin Hood solution" -- take from the rich and give to the poor. That never works. Give the poor money, and very quickly, they again are poor. But, give the poor a good education, and they lift themselves out of poverty. . It's a version of "Give a man a fish and you feed him for a day, but teach him to fish and you feed him for a lifetime." . Rodger Malcolm Mitchell
dgbalmer, . I began to read you very long comment, but was interrupted by a key, completely erroneous, assumption: " . . . increased consumer savings pool partly arose from tax cuts which government had to replace with borrowing."
The U.S. federal government is monetarily sovereign.As such, it has the unlimited ability to create money. It needs neither taxes nor borrowing. In fact, if both federal taxes and federal borrowing were totally eliminated, this would not affect by even one penny, the federal government's ability to pay bills of any size. . If, in view of the above, the rest of your comment remains valid, I'll be interested in reading it. Let me know. . Rodger Malcolm Mitchell
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