The dramatic increase in income inequality over the last ten years is not news to readers of this site, but the extent to which it actually caused the financial crisis is still not widely appreciated. As Ray Brescia pointed out this month in all the debates over the Dodd-Frank financial reforms, few in Congress raised questions about the impact of growing inequality on the very crisis that brought about the need for reform.
As a producer of documentaries and television programs there are different ways in which one can tell the story of what's happening to the economy. At Studio Lambert we produce two mainstream shows that probably only exist because they reflect the economic zeitgeist -- Undercover Boss on CBS and The Fairy Jobmother which launches this week on Lifetime. Arianna Huffington was kind enough to say that Undercover Boss sheds light each week on the chasm between America's haves and have-nots. She thought it put flesh and blood on statistics like the fact that thirty years ago top executives at S&P 500 companies made an average of 30 times what their workers did and now they make 300 times as much.
But to understand the real significance of this inequality one needs a more analytical approach than a reality show can offer. We've just finished producing a feature documentary called The Flaw that attempts to explain the underlying causes of the crisis in more depth than any documentary to date. The film premieres in the UK next month, but after a preview screening a couple of weeks ago at London's Royal Society of Arts, Matthew Taylor, Tony Blair's former head of the policy and now head of the RSA, wrote, "it is a terrific film, intelligent and persuasive, but also entertaining, witty and at times moving. Most fascinating to me was its core thesis; that the biggest driver of the crisis was wage and asset inequality."
So what is the film's argument? The title refers to Alan Greenspan's admission in his testimony before Congress that he had discovered "a flaw in the model that I perceived is the critical functioning structure that defines how the world works so to speak." A humbled Greenspan admitted that it had been a mistake to put so much faith in the self-correcting power of free markets and that he had failed to anticipate the self-destructive nature of wanton mortgage lending and the housing and credit bubble it generated. Greenspan had taken the view that the central bank shouldn't question increasing asset prices, it should only take action when they started to fall. He cut interest rates and tried to boost activity whenever there was the slightest drop. And, of course, boosting economic activity is just a euphemism for trying to encourage consumers and businesses to borrow even more.
The film highlights the fact that the only other time in the last century when top earners had such a high share of total income was just before the Great Crash. The share of total American income going to the top 1% peaked in 1929 at about 22%. After the Crash and the start of World War II it fell steadily so that by the 1970s the top 1% were receiving only 9% of national income. But then it started to rise again; in the last ten years it has shot up like a 4th of July rocket to about the same level as in 1929. This increase can largely be explained by the credit bubble that Greenspan presided over.
Economic activity, profit growth and credit creation are all intimately linked. As George Cooper, author of The Origin of Financial Crises: Central banks, Credit Bubbles and the Efficient Market Fallacy, explains in the film, "if the banks are more willing to lend it becomes easier for companies and households to spend, because they can borrow money. As credit rises, corporate profits rise which means pay and dividends rise. Well who tends to own the shares in the corporations and the shares in the banks? Generally it's the wealthier people that own the capital stock of an economy. So if profitability is being boosted then there's a natural tendency to polarize wealth distribution within the economy as well. It's a symptom of a credit cycle."
This new inequality can also be seen in the way that the bottom 90% lost out. In the three decades after the WW2 they were getting roughly 65% of national income, but since the 1980s it's fallen to 50% as the double whammies of the rise of globalization and de-industrialization hit the American workforce. What is often not appreciated is how this upward income redistribution in itself tends to ignite asset bubbles. As you go up the income distribution scale, what people spend their money on changes: there is a relative decrease in expenditure on consumer goods and an increase on housing and financial assets.
"The income redistribution created a bidding for houses," explains Cornell University's Professor Robert Frank. "People at the top buy mansions. People in the middle don't seem offended by that in America. They want to see pictures of the mansions. But when the people at the top build bigger, their bigger houses shift the frame of reference for people who are near them in the income distribution; people who have a lot of money, but not quite at the top. So you get a cascade one stage at a time that drifts down through the income distribution." Robert Schiller of the Case-Schiller Housing Index fame shows how house prices, when adjusted for inflation, remained flat for a century between 1890 and 1990 and then there was a huge bubble in the US starting in 2000.
"On the one hand you have home buyers who are struggling to make ends meet," argues Harvard economic historian Louis Hyman, "looking for the only way they know how to make money in our economy. They can't make money through their labor, so but maybe they can make it through buying a house and seeing the value of that house increase. So people look to mortgages, these easy-to-get mortgages as a way to finally get their share of the American Dream. And, on the other hand, the income inequality produced a ready supply of capital at the top to be invested in these kinds of mortgages. So while the top was not willing to pay the bottom higher wages, they were willing to lend them money."
The compelling, but flawed, logic of mortgage securitization finance is explained by some of its first-hand practitioners. And Josh Zinner and Sarah Ludwig of NEDAP, one of the many campaigning groups promoting financial justice for the low income communities, point out that the majority of the loans that were generated and then sold to Wall Street to be securitized were refinance loans.
They weren't adding to home ownership. 77% of the sub-prime loans made were refinancing loans made to people who had built up equity in their homes. "If you look at the deed records for low income neighborhoods," says Zinner, "you'll see so many homes where people were refinanced over and over and over, sometimes several times in one year until their equity is gone and they lose the house."
"The reason why the money gets allocated into consumer and mortgage debt," says Hyman, "is because it actually pays as a better return than investing it in businesses, than investing it in factories or things that make things. And it's this simple banal calculation that's behind all of this, it's not some greedy Wall Street banker. Wall Street bankers and all capitalists are always greedy, that's the basis of our entire system. It's that the opportunities for investment are different than they used to be."
This fall in the share in the bottom 90% represents a transfer upwards of roughly one and a half trillion dollars each year to the top 1%, calculates Professor Robert Wade of the London School of Economics. "This enormous upwards redistribution of American income took place in a stable democracy with governments that were promoting this upwards redistribution being re-elected time and time again. It's a very interesting question of how was the American elite able to get away with it. You have roughly one and a half trillion going up and a roughly one trillion a year coming down in the form of house equity refinancing. If the American population had been receiving something like the same income share as in the 1950s and 60s then they would have been able to increase their consumption in a sustainable way out of rising income. But that's not what happened." Instead, we masked a lack of income growth by the fact that people supported their living standards with more debt.
We all know what happened when the bubble burst. The film ends with Nobel-prize winning economist Joseph Stiglitz's pithy summary. "What we are doing in effect is transferring money from people who would spend it to people who don't need all that money and don't spend it; hundreds of people getting more than a million dollars a year, even when their company makes a loss. When you have growing inequality, typically your level of consumption goes down. In the United States we said to those whose income was not going anywhere don't worry continue to spend as if your income was going up. But the only way you do that is through debt and that particular model has been broken."
The Flaw premieres on 4 November at the Sheffield International Documentary Festival. It will be launched in United States early next year.
Vivian Norris: Documentaries: In Defense of Diversity -- Documenting Our Changing World
It's a really great theory, and if only it were true! Pension funds have long held the majority of equity in the United States. CALPERS has what, $250 Billion under management? College Endowments, in aggregate, are another major owner of equity. Sorry to be the one to burst your bubble.
As for the income inequality/depression arguments, both time periods also had large leveraged-asset bubbles pop. People took on risks trying to get rich, and paid a dear price. Regrettable. IMHO that is as equally compelling an explanation for 1929 and 2008 than is income inequality. Also, IMHO, it may be that income inequality is not a cause buy a symptom; perhaps it may be the canary in the coal mine; when it rises, then people appear to develop a "get-rich-quick" mentality, which starts with G which rhymes with T which stands for trouble (with apologies to Harold Hill).
Now I do agree that the get rich quick ideals are a major problem. Years ago 3% to 5% was blue chip, now everyone is looking for 12% or more. Companies will cut workers so they can generate an extra 1% in profit, Just to make the Fiscal Year numbers. Or people will dump their stock.
This whole thing makes my head hurt and it sure is easier to be upset with the people that walked away big winners.
I still think that those at the top tilted the playing field but there were enough of us down at the bottom and in the middle that stepped up to try our luck.
In the 90s, I talked to a recruiter who was beside himself with glee at the thought of offshoring jobs. He got quite a commission for every H1B visa holder he brought into the country. Companies like Microsoft opted for foreign workers instead of instituting trading programs in their company to keep existing employes ahead of the technology curve. Microsoft isn't the only company that sold out, but it led the pack.
The question now is how do we restore what was lost. The last crumble devastated the middle and working class, but many of the super wealthy are doing just fine...thank you very much.
How do we get our nation and all the nationalities, reglions, cultures representated to understand that while Capitalism provides opportunity, corrupt Capiltist takes it away.
Who do you think benefited from suppressed wages? The top 1%.
Its a cancer that will surely kill us.
I agree wholeheartedly with your estimation, but ... we don't have a gung-ho general in the White House now, and the people who would be taxed have bought out our government to such a degree that it would be very hard to actually get that 90% tax.
One of my favorite operas is Les Miz -- maybe it's time for a new revolution? Surely between the bulk of American citizens who are beyond sick of this current situation we should be able to come up with a concrete way to turn this around. Any ideas?
The one thing you can never do in America is question free trade with communist China or question federal interference in the labor market such as H-1B work visas.
The FED is the ultimate wealth redistribution scheme.
Why do you think half of all economists are surprised and wrong on every report?
You clearly subscribe to the wrong school of economics.
The same stimulus in the a US with a more even distribution of wealth and income would produce greater consumption and raise demand for goods and services. This would lead to more hiring, more income and more consumption and so on.
If the US did not have such a skewed distribution of wealth and income, the stimulus of 2009, even though inadequate, would have had a greater effect on production and unemployment. Gaining a greater control over the economy is one of the reasons, along with those touched on in the article, why wee need public policy aimed at reducing inequality.
I look forward to the documentary.
Did you pay for their college education?
Did you both inherit money?
Did you start out with large student loan debt?
Have either of you suffered through a major illness?
Have you been forced to care for elderly relatives?
Everybodies situation is different.
I'm happy for your success.
But we need policies that lift ALL boats.
The biggest, a hundred times each of these was the destruction of industry. Free Trade.
The American party will change free trade to equal trade. Equal meaning what it costs to produce in the USA. The American party will replace or put on legal steps so banks, power, medicine and fuel are controlled, so they can not feed off the US consumer. You have a choice, slow poverty while the super powerful corporations take turns impoverishing you or looking at the two parties that have allowed this and changing them in Congress and the White-House in 2012!
At the same time, maybe I shouldn't be so hard on Greenspan. Our elected leaders still don't seem to either understand or care about the fallacy inherent in deregulation.as guiding political theme. Just as we as a country seem to have learned nothing from the disaster in the Gulf of Mexico about the need for intelligent and prudent public policy, we've also learned nothing from the near second great depression of 2008. Unfortunately for all of us George Santayana got it right when he said,"Those who cannot learn from history are doomed to repeat it."
We need a new pragmatic approach to policy.
Do what works and let isms be hanged.
Most people just want a decent life, food, water, a home, a bed, and some pleasant times; they do not mind if there are other people who dream great dreams and plan great projects and accomplish great things while making themselves rich. People, really, don't envy the rich. What has people upset is the greed, the criminality, the vulgarity of the way the corporations and rich go about acquiring their money.
1. A living wage
2. Health care for them and their family
3. 40 hour work week or less with overtime paid double
4. Affordable housing with reasonable interest rates and terms
5. The ability to retire with dignity before they are too sick to enjoy it.
Does this sound Utopian. Hardly, its just a mater of deciding who benefits from the economy. It might mean fewer dollars for the top 10 %.