September 24, 2008 — For the past two or three decades skeptics watched as deregulated finance got ever more reckless, as the gap between rich and poor widened to a chasm not seen since the turn of the last century, and they said, "Someday there’s going to be hell to pay for all this." But despite a few nasty hiccups every few years — the 1987 stock market crash, the savings and loan debacle of the late 1980s, the Mexican and Asian financial crises of the mid-1990s, the dot-com bust of the early 2000s — somehow the economy regained its footing for another game of chicken. Has its luck finally run out?
It might seem odd to link the current financial crisis with the long-term polarization of incomes, but in fact the two are deeply connected. During the housing bubble, people borrowed heavily not only to buy houses (whose prices were rising out of reach of their incomes) but also to compensate for the weakest job and income growth of any expansion since the end of World War II. Between 2001 and 2007, homeowners withdrew almost $5 trillion in cash from their houses, either by borrowing against their equity or pocketing the proceeds of sales; such equity withdrawals, as they’re called, accounted for 30 percent of the growth in consumption over that six-year period. That extra lift disguised the labor market’s underlying weakness; without it, the 2001 recession might never have ended.
But that round of borrowing only extended one that had begun in the early 1980s. At first it was credit cards, but when the housing boom really got going around 2001, the mortgage market took the lead. Now households are up to their ears in debt, and the credit markets are broken.
Borrowing is only one side of the story. As incomes polarized, America‘s rich and the financial institutions that serve them found their portfolios bulging with cash in need of a profitable investment outlet, and one of the outlets they found was lending to those below them on the income ladder. (That’s one of several places where all the cash that funded the credit card and mortgage borrowing came from.) They also poured their money into hedge funds, private equity funds and just plain old stocks and bonds. That twenty-five-year gusher of cash led to an enormous expansion in the financial markets. Total financial assets of all kinds (stocks, bonds, everything) averaged around 440 percent of GDP from the early 1950s through the late 1970s. They grew steadily, breaking 600 percent in 1990 and 1,000 percent by 2007. With a few notorious interruptions, it looked like Wall Street had entered a utopia: an eternal bull market. Regulators stopped regulating and auditors looked the other way as financial practices lost all traces of prudence. No figure embodies that negligence better than Alan Greenspan, who as chair of the Federal Reserve dropped the propensity to caution and worry characteristic of the central banking profession and instead cheered the markets onward. As he said many times in the 1990s and early 2000s, who was he, a mere mortal, to second-guess the collective wisdom of the markets? He seemed to have no sense that markets embody no collective wisdom and often act with all the careful consideration of a mob.
So while the proximate cause, as the lawyers say, of the current financial crisis is the bursting of the housing bubble and the souring of so much of the mortgage debt that financed it, that’s really only part of a much larger story. And while it’s inevitable that the government is going to have to spend hundreds of billions to repair the damage over the next few years, there’s a lot more that needs to be done over the longer term.
This is the point where it’s irresistibly tempting to call for a re-regulation of finance. And that is sorely needed. But we also need to remember why finance, like many other areas of economic life, was deregulated starting in the 1970s. From the point of view of the elite, corporate profits were too low, workers were too demanding and the hand of government was too heavy. Deregulation was part of a broad assault to make the economy more "flexible," which translated into stagnant to declining wages and rising job insecurity for most Americans. And the medicine worked, from the elites’ point of view. Corporate profitability rose dramatically from the early 1980s until sometime last year. The polarization of incomes wasn’t an unwanted side effect of the medicine — it was part of the cure.
Although we’re hearing a lot now about how the Reagan era is over and the era of big government is back, an expanded government isn’t likely to do much more than rescue a failing financial system (in addition to the more familiar pursuits of waging war and jailing people). Nothing more humane will be pursued without a far more energized populace than we have. After this financial crisis and the likely bailout, it looks impossible to go back to the status quo ante — but we don’t seem ready to move on to something appealingly new yet, either.
This article appeared in the October 13, 2008 edition of The Nation.
Doug Henwood, editor and publisher of Left Business Observer, got his B.A. in English from Yale in 1975. At Yale, Henwood was briefly a conservative and a member of the Party of the Right, which maneuvered his election as Secretary of the Political Union, but he quickly came to his senses. From 1976-79, Henwood did graduate work in English at the University of Virginia, concentrating on British and American poetry and critical theory, fulfilling all requirements for a PhD except for that great stumbling block, a dissertation. After two years working as a copywriter and under-assistant promotion man for a medical publisher in New York, Henwood revived the idea of writing his dissertation, which was to be an examination of the varieties of narcissism in American poetry from Emerson through Whitman to Stevens. To examine the evolution of this psycho-esthetic, Henwood planned to examine the evolution of the U.S. political economy as well, from the entrepreneurial-yeoman capitalism of Emerson`s day to the finance-bureaucratic capitalism of Stevens` - which would have taken seriously Stevens` employment as a bond lawyer for The Hartford insurance group. The dissertation was never written. But in the course of boning up on the theory and history of the U.S. political economy, Henwood got more deeply interested in economic matters and less so in literary ones, supplementing a decent base of undergraduate training with extensive self-teaching. After 5 years of contemplation, convinced that the 1980s experiment with free-market economics was a financial and social disaster and that much "left" writing on economics was usually dry and dated, Henwood decided that there was room for a newsletter addressing both these deficiencies. He founded Left Business Observer in September 1986. Almost from the first issue, the newsletter was a critical success, and, though the publication more than pays its bills, a vast cascade of subscriptions would always be welcome. LBO covers economics and politics in the broadest sense. Recent and persisting obsessions include income distribution and poverty in the U.S. and elsewhere in the First World; the evolving Western hemisphere free trade zone and the Mexican crisis; the globalization of finance and production; the worldwide attack on pensions; Third World debt and development; the transformation of the former "socialist" world; the IMF and World Bank; the media business; the influence of foundations on politics and culture; the meanings of Clintonism. Every issue includes a report on the world`s financial markets and central banks. Besides editing LBO, Henwood is a contributing editor of The Nation and hosts a radio weekly program on WBAI (New York). He has written for numerous magazines and newspapers around the world, and has contributed chapters to a number of scholarly and popular anthologies. His social atlas of the U.S. (in the Pluto atlas series), The State of the USA, was published by Simon & Schuster in the fall of 1994, and his book Wall Street was published by Verso in June 1997, to great critical acclaim. It was also a smashing best-seller, as these things go; an updated paperback version was published in June 1998.
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