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Fear and Looting in America: What Really Caused the GM Bankruptcy?

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"I've never quite been in this situation before of getting a massive pay cut, no bonus, no longer allowed to stay in decent hotels, no corporate airplane. I have to stand in line at the Northwest counter. I've never quite experienced this before. I'll let you know a year from now what it's like."
- Bob Lutz, GM Vice-chairman after December 2008 auto industry bailout.

Poor Mr. Lutz finds himself in a strange land -- America. He is being forced to go native. For the last 30 years, he along with the super-rich severed their social connections with the rest of us. Now, they no longer live anywhere near us (or if they do, it is behind well-protected walls, fences, and gates.) Their kids don't go to our schools. They don't ride on our buses and trains, and they're not in line with us at the airport either. They don't see our doctors or go to our hospitals. So they don't suffer the indignities of our crowded services and collapsing infrastructure. And here's why.

Take a look at the following graph compiled for The Looting of America. It shows how much the top 100 CEOs received per year in total compensation as compared to each dollar earned by the average American worker. It also provides a critical key to understanding the economic crisis.

2009-05-31-images-09.jpg

No other nation in the known universe has so large a gap. (Using a larger pool of executives for international comparisons, the estimated gap in 2000 was 365 to 1 in the U.S. The next highest country was South Africa at 51 to 1. All of Western Europe, Japan, Canada and Australia were 25 to 1 and below.)

What does this have to do with the GM bankruptcy? Everything.

The rising CEO wage gap is a stark indicator of a destabilizing flaw in our economy: Since the mid-1970s, the top fraction of the top one percent has garnered the lion's share of rising GDP. According to theory this was supposed to lead to vast increases in investment which in turn would lead to new industries, more jobs and rising wages for the rest of us. In reality, real average worker wages stalled throughout the past three decades instead of being lifted by the market-utopian rising tide.

Some of that elite money did go to new investments in the real economy. But so much money had drifted to the top that the super wealthy literally ran out of productive investments in the goods and non-financial service sectors. (Of course, crumbling schools, damaged highways and an environment in crisis went begging for investment dollars. But that's to be expected when we slash taxes on the wealthy.)

The leftovers, which were considerable, turned into "surplus capital" that needed a home. Here's how Wall Street Journal reporters Greg Ip and Mark Whitehouse put it in 2005:

There's an unprecedented wave of capital flowing around the world, with all of its owners anxiously searching for a better return....The result is that global investors are diving into a wide range of riskier assets: emerging countries' stocks and bonds; real estate and real-estate-backed debt; commodity funds; fine art; private-equity funds, which buy stakes in nonpublic companies; and the investment contracts called derivatives, including a kind structured to permit the sophisticated to take huge bond risks.

Wall Street players are not stupid. You work there and you develop a nose for finding pools of capital and for luring them into your investment house. So the financial engineers created a slew of new derivatives called "structured securities." We're talking CDOs, CDOs squared, cubed, sliced and diced to suit your every whim. From the early 1990s, derivative bets of all kinds were created to attract and soak up this surplus capital. The problem was that most of these securities were not based on actually owning real tangible assets. You owned a bet, not a mortgage or a loan or a piece of a corporation. Most of these financial products have since turned into toxic assets.

This should come as no surprise. Research shows there's a very strong correlation between rising income gaps and financial crashes. In 2004, economists Jamal Rashed and Subarna Samanta statistically tested whether this gap caused financial instability. They concluded that when the discrepancy between rising productivity and wage stagnation is large, "stock markets crash, banks fail, currencies depreciate, unemployment rises, and a longer recession or a full-fledged depression may follow."

Inevitably, the more money that accumulates at the top, the greater the chance for asset bubbles to emerge (and inevitably crash) as the surplus capital seeks riskier and riskier investments. Our economy always does better when average real wages rise. It creates a virtuous cycle. Working people spend nearly all of their money in the real economy and do not risk their savings on derivative bets.

The financial system collapsed under its own weight: Too many unregulated casino games that ran wild on too much money from those at the top. This fantasy finance crash tore a gaping hole in the world economy. Banks and financial institutions found their books loaded with toxic assets and teetering on the edge. The credit system froze solid and shut down economic activity all around the globe. In the auto industry, the financial crash cut global sales from about 17 million vehicles to less than 10 million.

Yes, GM's managers could have done much more. And surely, the U.S. car industry would be more competitive if we, like other nations, had national health insurance to cover worker health benefits. But there would be no GM/Chrysler bankruptcy had the financial sector not imploded -- a direct result of policies which allowed wealth for the few to get completely out of hand.

The Obama administration is investing in the US auto industry because letting it go down would create an even larger crisis in national employment and further tear the economy apart. But this is just a defensive measure. Whether you believe the current income distribution is the bedrock of free-enterprise or whether you think it is an abomination, we have to square up to the fact that unless we put more money into the hands of the middle and lower income groups, we're cooked.

We know what needs to be done: Steeply progressive income taxes like we had during the 1950s; regulation of all derivatives; a small fee on financial transactions to repay society for the enormous subsidies going to Wall Street; and a cap on salaries ($400,000) at any company receiving bailouts.

We'll be a much stronger nation when the Bob Lutzes of the world have incomes more like the rest of us -- and find themselves once again living in America.

Les Leopold is the author of The Looting of America: How Wall Street's Game of Fantasy Finance destroyed our Jobs, Pensions and Prosperity, and What we can do about it. (Chelsea Green Publishing, June 2009)