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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.)

By Ezra Klein  |  May 19, 2009; 2:09 PM ET
Categories:  Financial Crisis  
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The graph you post is a glaring example of the sad state of our society. The rich have gotten richer and the rest of us have been part of a Ponzi scheme wherein our homes got 'higher' in value because, well, everyone THOUGHT they should- even when it was obvious that few people could afford the prices as they escalated. Since wages were stagnant, the only way to buy things to keep the economy going was through bogus home 'equity' and credit cards. Of course, at some point people began to realize they could never pay back what they owed.

At this point, considering that the ten percent of the country who owns the vast majority of the wealth in this country will never share it with the other ninety percent and wages are never going to make up the difference, perhaps now would be a good time to announce that all credit card balances will be reset to zero and all home equity loans will be forgiven.

That would certainly pump up the economy as regular people would have more money.

Posted by: bokun59 | May 19, 2009 2:48 PM | Report abuse

No offense, Ezra, but your "counterfactual" article borders on the "counterstupid." Maybe you're just trying to be countersarcastic. I certainly hope so.

Although I agree with your second point, the first point is just plain not true.

The repeal of Glass-Steagal was one major deregulation that took place--combining banks and investment banks--that helped cause this mess. Then, there are the regulators who gave nice little warnings about "exotic mortgages" that turned into "toxic assets."

Interest-only loans to unsophisticated borrowers? Give me a break. Just doing those loans in the first place turned houses into stock certificates so that we saw a replay of the manic dot-com bubble take place. Only this time, they were tied to houses to mortgages to credit default swaps, derivatives, etc. b/c Glass-Stegal was repealed.

Niall Ferguson said we have to credit how we got here, but we got here under false pretenses--driven by Wall Street greed that trickled down and perpetuated the greed embodied in human nature. However, Ferguson did a great job explaining this mess in "The Ascent of Money," a PBS documentary well worth watching.

As for the middle-class buying things rather than investing with their hard-earned money...isn't that the Reagan/Bush materialistic quotient that put us here in the first place?

Compare another graph of the amount of debt that started rising in 1980-present and how unemployment continued to decline as private sector debt increased. Then you see what this economy has been all about for almost 30 years.

Just maybe, we're coming into a time when money is not the be-all and end-all, and we move away from F. Scott Fitzgerald's "The Great Gatsby" to a culture with more substance.

That way, we save, compound interest and don't feel that we're losers for not making a million dollars a year. I know this sounds crazy, but it is only money.

Unfortunately, so many people have lost jobs these days that now they really do have to worry about earning it to survive.

Posted by: mmurray1 | May 19, 2009 3:00 PM | Report abuse

Thanks for sharing that income graph right when the guy who gave us the "Laffer curve" is writing in the WSJ about the despicable taxation the rich are being subjected to these days - and how it is forcing them to move.

"Trickle down" has worked brilliantly for that top tier of wage earners. Not so well for those below....the trickle never seemed to go down.

And it's nice that the "deregulation" we've seen in the last couple of decades has proven once and for all that the highly compensated, highly educated guys in finance can't function properly without the feds acting like a helicopter parent, propping up the bankers with rules, regulations and the riches of a bailout.

Posted by: anne3 | May 19, 2009 3:27 PM | Report abuse

The $64K question is WHY have median wages stagnated for 30 years and, more importantly, HOW does that trend get reversed?

Yes, I believe that tax policies favoring the rich have helped the rich get richer, which created vast pools of money that couldn't be spent, which was then used to finance all this wonderful financial innovation....we know the rest.

But what now? Yes consumers need to delever and pay down debt and live within their means, but how do we increase their means?

It looks like the last 30 years of growth have been a mirage, supported by low savings and high debt rather than real growth. But the US now lives in a global world where there is immense downward pressure on American wages, particularly in low skill/low substitution cost professions. I guess education plays a piece but it's not a magic bullet. The real question is how do we find sustainable wage growth for the vast middle class?

Posted by: dbelanger | May 19, 2009 3:41 PM | Report abuse

Watch your units. I emailed Matt Yglesias a heads-up about this and I think I just about have him convinced. That graph doesn't show what he says it shows, because it measures HOUSEHOLDS, not individuals. It's easy to miss because it doesn't say that on the title of the graph, just at the top of the CBO web-page that Matt links.

Yes, real household income, at least for the median and the lower four quintiles, has stagnated for thirty years (more than that, actually). The reason, though, is that household size has been shrinking dramatically as more people delay marriage or can afford to live alone. What may have been a three-person household in 1979 is now as low as two. The fact that most of the much smaller households of today earn the same real income as much larger households of thirty years back (and a not-insignificant number earn much more) is in itself a remarkable sign of growth.

If you want to make the point Matt makes, you need to look for a chart that shows PER CAPITA income by HOUSEHOLD income quintile. That would show you what the average person in a "rich" household can consume compared to the average person in a "poor" household. Until you put up that data, though, you can't say that real incomes have stagnated. In the meantime, you really should clarify the point.

Posted by: JohnOfCharleston | May 19, 2009 6:41 PM | Report abuse

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