How Inequality Accelerated the Financial Crisis
Historian Niall Ferguson took to the New York Times this morning to argue that "if deregulation is to blame for the recession that began in December 2007, presumably it should also get some of the credit for the intervening growth." This doesn't make sense on two levels. First, it's a straw man. Deregulation isn't to blame for the recession that began in December 2007. You can make an argument that an absence of new regulation was to blame. But it's not as if we shuttered the agency regulating credit default swaps in 2006. That agency never really existed. The regulatory state didn't keep pace with the financial sector.
Second, the point itself is illogical. It's like saying, "if driving drunk is to blame for me hitting the tree in my front yard, then it should also get some credit for getting me there in the first place." The relevant question is what would have happened if you weren't driving drunk. The answer, probably, is you would have arrived at your destination without hitting the tree. Similarly, the question is what the financial sector would have looked like with a sounder regulatory regime. Ferguson doesn't entertain the counterfactual, and so doesn't prove his point.
But he did spur Matthew Yglesias to post this graph tracking wage growth over the past 30 years, which bears on a related counterfactual:
As Matt writes, "for the top one percent, that’s a pretty impressive period. For the next 19 percent, there’s something happening. But for the bottom 80 percent, there’s just very little going on in terms of real income growth." Two things emerged from this. First, the middle class wanted to maintain, and even expand, its standard of living. So it went into debt. It borrowed on credit cards and refinanced its mortgages. Bad news, as we're seeing now.
Second, the new money in the economy was disproportionately concentrated in the bank accounts of the richest of the rich. But at some point, even the very wealthy run out of vintage wines to purchase. So they put that money to work making them more money. They funneled it towards the financial sector and created a massive new market for financial innovation.
Conversely, you could imagine a counterfactual where growth was more equitably distributed and the middle class saw their incomes rise. Rather than buying financial products, they would have bought things. Cars. Televisions. Couches. Viking stovetop ranges. In the aggregate, they would have used the money to consume rather than to make more money. And that would likely have kept the financial sector somewhat more in check.
(Graph courtesy of the Congressional Budget Office.)
May 19, 2009; 2:09 PM ET
Categories: Financial Crisis
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