(The need to strengthen the economy by addressing income inequalities, decreasing corporate influence on politics, and increasing investment in public education)
In 1929 and then again in 2007, income inequality reached a peak in the United States. In both years, the top 1% of workers earned roughly 25% of all income. And both times, this was followed by economic collapse – the Great Depression in 1929 and the Great Recession in 2007.
The Great Recession is often explained as a “subprime mortgage crisis.” According to this narrative, risky home loans were made to sub-prime borrowers. These loans were then packaged into mortgage-backed securities (securitization), which were in turn repackaged into a variety of other securities (various forms of collateralized debt obligations, etc.). There didn’t seem to be a problem as long as the economy was strong and home prices were rising. However, when these trends reversed, the entire construct collapsed. Individuals could not meet their mortgage obligations, and they defaulted on their loans. Homes were then foreclosed upon and put back on the market for resale. This led to an excess supply of housing which caused prices to decline, which led to an increasing number of families with underwater loans, and then more defaults, etc. This vicious cycle had serious negative implications for the economy. By March, 2009, the Dow Jones Industrial Average had fallen to 6,547, a drop of over 50% from its prior high of 14,164 in less than eighteen months.
Recently, a number of scholars (e.g., Harvard’s Jeffrey Frieden and Wisconsin’s Menzie D. Chinn; and Harvard’s Carmen Reinhart and Kenneth Rogoff) have compared the Great Recession to other historical economic crises around the world, and concluded that there was nothing unique about the Great Recession. In addition, they claim that it is not best described as a “subprime mortgage crisis.” Instead, they refer to it as a “capital inflow crisis.” In this narrative, the root of the crisis was the large budget deficits in the United States. Domestic spending was too high relative to domestic output (leading to deficits), which effectively meant that capital was flowing into the United States. This excess capital caused demand in the housing sector to be artificially high, leading to price inflation in housing – the housing bubble. Some economists, such as Yale’s Robert Shiller, warned about the risks of this bubble prior to its collapse. This problem of capital inflow was then compounded by poor regulation that encouraged lending to individuals with poor credit. The Community Reinvestment Act (whose lending standards were relaxed in both the Clinton and the Bush II administrations) encouraged home lending to individuals with low credit scores. Thus, budget deficits and inadequate regulation established the foundation for the Great Recession.
In addition to this recast explanation of the Great Recession, there are three additional facts that are critical to remember. First, the Great Recession was a crisis that was driven largely by federal government policy and by Wall Street financial speculation; and yet the brunt of the damage was borne by state governments and by Main Street. State budgets were decimated by the Great Recession – leading to teacher layoffs, a decline in state support of higher education, cuts in public services and infrastructure neglect. MIT’s Simon Johnson and co-author James Kwak write: “On issue after issue, the big banks got what they wanted, and the taxpayer got the bill.” Second, the regulatory reforms implemented in the aftermath of the Great Recession are seen by many as inadequate. Johnson and Kwak continue: “…and absent fundamental reform, there is no reason to believe bankers will refrain from inventing new toxic products and precipitating another crisis in the future. What’s more, given the growth and the size of the leading banks, the next crisis is likely to be even bigger.” Third, unlike the aftermath of the Great Depression, when the New Deal and other reforms led to a decline in income inequality, there has been no decline in income inequality in the aftermath of the Great Recession. In fact, income inequality is increasing.
This leads to the question of implications going forward. As the economy rebounds (the Dow Jones Industrial Average peaked at an all-time high of 16,945 this week), it is imperative to incorporate several principles in the development of subsequent policy. First, there must be increased regulation of financial markets. Second, the role of corporate influence in the political system must be diminished. Third, as state budgets improve with the rebounding economy, investments must be made in areas decimated by the Great Recession (e.g., public schools, higher education, transportation infrastructure, social services, etc.). Fourth, the persistent income inequalities in our society must be addressed. For my proposals on implementing policy to achieve these objectives – please see the "Campaign Objectives" section of my website.
- John Stafford
References: Menzie D. Chen and Jeffrey A. Frieden, Lost Decades: The Making of America’s Debt Crisis and the Long Recovery. Carmen Reinhart and Kenneth Rogoff, This Time is Different. Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown.