The title of this post borrows a phrase from Michael Hudson – an economist, archeologist and historian – who shows that increased indebtedness is the main reason for our economy’s current decline (“debt deflation”), and that real estate loans are the main tools used by financiers to increase indebtedness. More and more people are unable to keep the property they bought. Even whole suburban developments are being abandoned. This growing debt and it’s bad consequences in all the developed countries (and the less developed countries that depend on them), he calls the “Slow Crash“.
Robert Reich’s critical comments about the history of crashes, and the current bubble support what Hudson says completely although his record of public service is more well known, and his ideas more in the mainstream media. His ideas are found in this recent Salon post.
I realize Hudson’s views go against reports in mainstream media, which cite economists and the data they use, claiming the economy is doing well today. He answers that the popular reports are simply wrong, and shows convincingly that the analyses are incorrect, and the data they include are misleading, on purpose. Many ordinary working class people must experience that they’re getting deeper in debt, and their pay doesn’t match the cost of living. If they believe the media, they’re encouraged to blame this on immigrant workers, or bad luck, or think they are not the norm, and others of their class are probably doing better than they are.
Hudson is not suggesting a ‘conspiracy’ is behind the deceptions and misrepresentations. No, a few people did not gather together secretly somewhere and agree to keep the general public ignorant. Millions of people in businesses of all sorts – from one person to employers of many thousands – have accepted the modern business model, including the modus operandi – “Keep your customers happy, and ignorant”.
There are about 30 million businesses of all sorts and sizes in America, not counting farms. What fraction of all these firms deceive their customers no one can say, of course. But the ones who have the most influence on lawmakers, and the most effect on public opinion are the companies with the greatest stake in the game – i.e., the highest income. Generally that means the Wall Street moguls, in the Finance, Insurance and Real Estate (F.I.R.E.) sector. It’s part of the ‘financialization of everything’, described well in Chris Hedges’ 2010 book Death of the Liberal Class.
I’m the same age as Hudson, and share his long-term views of economic, social and political trends. Being old gives people a chance to reflect on the past and the future (if their minds still function fairly well). There’s little doubt that most American’s don’t give much thought to either the past, or the future. Consumers say ‘Buy now; pay later (if you can)’. Businesses enable and encourage that desire for instant gratification, as they always have. (Romans said Caviat emptor -“Let the buyer be ware”.) I think both groups have a false view of what happiness means, and both try to ‘have it now’. On the business side, if time spent is money lost, the aim would be to reach zero time spent, and instantaneous payoff. “Fast Company Magazine” honors such efforts.
For over a century, home ownership has been one of the marks of middle class life. It’s a big part of the American Dream for people who start out poor – like immigrants and laboring workers – but hope to leave their tenements behind them. Unfortunately, realizing that dream is becoming less likely. In fact the middle class itself is diminishing. And today’s “Millennials” are questioning the old assumptions about home ownership.
Inflation, and the “bubbles” they lead to, are ancient troubles, since the time that money was first used (in Mesopotamia, 5000 years ago). But interpreting what inflation meant in those cultures, why it happened, who was affected and how, are matters of academic dispute. There’s no dispute however about the well-documented events since the 17th century, such as these five classic asset bubbles , one of which sucked in Isaac Newton. Today’s Wall Street gamblers aren’t as smart as Newton, but the money fever affects them equally.
Today’s bubbles are mainly the result of investment bankers taking advantage of new technologies, poor regulation, and political influence. When something goes wrong – as it did in the 2007 global financial crisis, resulting in bailouts of banks “too big to fail” – they claim that whatever harm was done resulted from unforeseen events, or by mistakes that have been fixed by company policy changes or regulation. All false.
In fact, executives in the financial industries took credit and immense pay packages, for the alleged success of their actions, even though they left their institutions at greater risk, the taxpayers holding the tab for the bailouts, and the economy in worse condition as results of their business models and personal choices.
Banks are still “too big to fail”, as Randy Wray shows, and their executives know that the government will bail them out again, so they continue the risky investment games. (See end.) No chief executive has even been prosecuted for his
or her role in the 2007 GFC.
John Kay is another long time observer with first hand experience (in Scottish banks), who discusses this hubris, and devil-may-care attitude. “I’ll be gone; you’ll be gone.” His 2015 book on culture shifts in modern banking – Other People’s Money: The Real Business of Finance – shows the history of this degeneration, and what may help it. I especially like his idea of keeping separate (as used to be the case) the mundane, day to day banking services the public absolutely needs, and the complex investment schemes that bring fast gains and high risk only for the benefit of bank executives.
Kay adds that real (not ‘captured’) regulators are needed – not more complex regulations. Regulators should understand the functioning of financial institutions, have the public good in mind, the judgment to see bad schemes developing, and the authority to intervene. Written regulations are easy to get around in court, which investment financiers have the resources to do. Or, as is common, they can register their transactions in countries whose politicians find it pays to make laws that don’t interfere with international financial gaming.
I’ve watched the growing debt pyramid a long time too, but not from Hudson’s or Kay’s vantage point as economists with direct banking experience. My picture is a bit bigger (and so less detailed) – more of a critical ‘philosophy of debt’ than a criticism of bad economic thinking – since I’ve had a long career of teaching philosophy, critical thinking, comparative religions and ethics. I summarized these ideas in Inequity, Iniquity and Debt: A Critical Overview of Money-Making, Macro-Economics & Public Purpose.
Strangely, the older I am, the more liberal my thinking becomes, economically, socially and politically, although admittedly those terms are hard to define. This goes against the norm, it seems. An old saying expresses the more normal change of view as people age, but doesn’t explain it. “If a man is not a socialist by the time he’s 20, he has no heart. If he’s not a conservative by the time he’s 40, he has no brain.” But 40 is still young, in a normal life, and old age will bring more variables to change one’s place on the conservative-liberal spectrum.
My liberal perspective grew in spite of being raised in a conservative household, and despite the fact that I lived an upper middle class lifestyle from childhood to the present. In the early ’80s, with my generous salary teaching in a community college and help from my wife’s parents, we financed a home before we turned forty, and were lucky enough to keep the middle class life we grew up with. Although good education is said to be necessary for a middle-class life, financialization makes that harder now, both for students, and for teachers, whose salaries are under downward pressure by school business managers.
I’ve been luckier, had more opportunities, and received more help than those I see and read about who are no longer in the middle class. Some have been priced out of their homes, and many have no prospects of retirement from whatever work is still available to them. My negative judgments about the direction our country is taking, and anger against the people who determine that direction, are not reactions to personal hardship. They result, rather, from years of researching the issues, confirmed by seeing at close hand the problems of my children and friends.
Everyone now knows a ‘housing bubble’ caused the GFC (Global Financial Crisis), and the Great Recession that followed. What they don’t know as I said above, is that recession continues for ordinary people, and that we’re in another housing bubble, caused in the same way. This will leave the real economy in worse condition than the previous one, and ordinary people even farther from home ownership. What they do know is that housing is getting more expensive, for owners and renters, that their wages don’t go as far as they used to, and that the idea of retirement seems beyond their realistic prospects.
Most people don’t know the underlying causes of these bubbles and recessions and the general economic decline. As said above, they think the economy is doing well overall, because they watch the media that says so. The financiers and politicians (of both parties) who make the policies and fiscal choices, and the corporate media who determine public opinion, want people to be ‘happy and ignorant’. If some are unhappy with their present troubles, they’re still ignorant. ‘Don’t worry, be happy. Things are improving’. And if the richest are getting even richer, that’s nothing to be upset about. What they’re doing – wealth production – is only what everyone wants, but not everyone is equally good at it. It’s not unfair, they’re told.
Hudson says this so-called “wealth production” is a euphemism for all the ways financiers use to redistribute wealth upward, at the expense of those below them. He summarizes the most significant of these ways in this interview by Adam Simpson at The Next System Project. Here is a section of that discussion, showing the real reason for housing bubbles:
“If you’re looking at how wealth is accumulated, people think of it in the way textbooks describe: as earning income and saving it up to get rich. That’s all most wage earners can do. But that’s not how it happens at the top of the pyramid.
Most wealth takes the form of capital gains. They’re inflated on credit, so it’s really asset price inflation that’s financed by debt leverage. Most of the gains end up being paid out as interest, so the bankers – that is, the bank owners and bondholders – end up with most of the rise in wealth.
If you’re a financial manager, you look at what’s called total returns. You add the capital gain to your current income. Most capital gains are obtained in the economy’s largest sector, which doesn’t appear in the academic curriculum: real estate, followed by oil and gas and other natural resource extraction. But to look at academic economics, it’s as if the whole economy is about making things – as if manufacturing hires labor to produce goods and services that everybody gets rich from, by being more productive. Savings are supposed to finance growth, increasing stock prices because profits go up from employing more labor to produce more goods and services.
But that’s not really what happens. Most money is made by financial engineering, not by industrial engineering. It’s made by what the classical economists called unearned income. 80% of bank loans are to the real estate sector. The more loans banks make to the real estate sector, the more their credit bids up real estate prices. People think that real estate goes up because of population growth and people getting richer to afford paying more. But that’s not really why housing prices are rising.
The value of a home or commercial office building is worth whatever a bank is willing to lend against it. As banks loosen their lending standards, they lend more and more. The result is debt pyramiding – and this is true not only for real estate, but for the economy as a whole.”
Even though the leaders of the financial world say they are providing capital to entrepreneurs to make quality products, which compete fairly for customers, and provide employment for the workers who produce them, and who buy them with competitive wages, that is neither the practice nor the goal of financiers. That’s old school, which means it’s too oriented toward long-term growth and fair competition in the real economy. Today’s financiers are interested in immediate gain, for themselves, however they can get it.
They get it by various forms of gambling (what they euphemistically call ‘high risk investment with appropriate high returns’). They bet that their “derivative” financial products, like CDS (credit default swaps), CDO (collaterized debt obligation), MBS (mortgage backed securities), etc. – what Warren Buffet in 2002 called “financial weapons of mass destruction” 5 years before the GFC crash – will enable them them to beat out their less sophisticated Wall Street competitors.
These products are mostly OTC (Over the Counter) contracts between parties, opaque to the general public, permitted by weakened or non-existent regulations in America, and often using overseas intermediaries, where government laws are more permissive. They stir the pot continually, with faster and faster access to what the financial market is doing, enabled by IT technology that permits automatic action (without specific human choices). Senators Sanders and Warren suggest putting a tax on every such transaction – not to make tax income, but to discourage this unproductive pot stirring. All this is nicely outlined in Wikipedia’s article: “Derivative (finance)”. Despite these suggestions by a few high level politicians, in practice, government tax and interest rate policies always favor those who control the debt pyramid.
This gambling has no measurable value for real economies anywhere (and has many negative real effects). To see this, compare the total amount of money it generated around the world (led by Wall Street moguls) to the total wealth of all the world’s economies (measured in GDP). Total money generated by derivatives is seen in this graph. Keep scrolling!
Total world wealth apart from the Wall Street gamblers is about $107 T (GDP, measured in ‘Purchase Power Parity’) described in this Quora comment. It might be as much as $241 T, counting all kinds of wealth, “cashed in“. By either estimate (and of course they are estimates), the wealth made by financial gambling, going to a few of the “1%”, by the most conservative estimate, is 5 times all the real wealth of the world, and by other estimates, 10 times that much ($1.2 Quadrillion)! I recall a comment, often misattributed to Illinois senator Dirksen: “A billion here, a billion there; pretty soon you’re talkin’ real money”. That was said 50 years ago. Today’s numbers aren’t just in a different ball park; they’re in a different universe!
The ‘brightest and best’ graduates of Harvard and other top universities are recruited to do this unproductive gambling. They are the most inventive, motivated, technologically sophisticated, mathematical-algorithm-business-model-savvy young people, and their pay is twice what it would be in truly productive businesses helping the real economy. These newcomers eagerly follow “Leaders” in this money-making business like Jamie Dimon and other Wall Street bank CEO’s, including those who oversaw the Fed and Treasury bailouts of the TBTF banks and joked about the fortunes they made from the banks they helped.