Melting Down and Sinking into Debt

Juliet Schor

An analysis of the financial crisis by Dr. Juliet Schor

With the financial system in a meltdown, the underlying economy in recession (or worse), the American Dream is in even more in jeopardy than usual. Millions of Americans are wondering who caused this disaster, what does it say about the role of government in the economy, how much is due to "greed" as the simplistic political discourse suggests, and whose greed? Individuals who wanted homes? Bankers and Wall Streeters whose obsession with money grew to mythic proportions? How much is this a morality tale? A political saga? Growing pains for a global economy? Business as usual?

The process of assigning blame for the financial meltdown is in its early stages, and it will take economists and other analysts time to sort out exactly what has happened and how things unraveled to such an extent. But some dimensions of the crisis are already clear. The first, which has been widely reported, is that financial markets began creating it with complex new types of mortgages, and other exotic “assets that were impossible to value. That in turn led the Federal Reserve and government regulators to turn a blind eye to the growing levels of risk and lack of transparency in the system.

They shouldn't have. Both the private and public sector actors forgot the lessons of history. Unregulated financial markets have always been wildly unstable, and financial panics like the one we’re living through were regular events. The Great Depression was so severe that it led to regulation designed to prevent economy wide crashes like the one we’re in.

But recently, Wall Street has used its expanding influence to amass record profits and flexed their might to craft regulatory policy and legislation to their liking. They have been exercising a dangerous level of control over government agencies whose job is to police these companies in the name of the public.

Another dimension of the story is that financial interests have been gaining power relative to other businesses for 25 years. They used their expanding influence to get massive profits and craft regulatory policy and legislation to their liking. (Remember the retrograde bankruptcy bill that the credit card companies got through in 2005?)

What about ordinary citizens? Isn’t the downturn due to people being irresponsible and taking on too much debt, especially in the housing market? While there are always some abusers of any system, pinning this crisis on poor people who wanted to buy houses, or even people of means who took on multiple mortgages, or excessive debt, looks at the problem backwards, and puts far too much causal stress on the proximate cause (the sub-prime meltdown of months ago). We have a system that has been constructed to operate on debt—the health of financial institutions depends on it. When competition heats up they have to lend more aggressively to keep pace. Industry looked to keep siphoning from a well of unsustainable loans, sold with tricks such as adjustable rates, teaser rates, lack of income verification and other methods to milk more money from consumers. Individuals have been the focus of a big social push for home ownership, which started out as a cornerstone of the American Dream.

The government gives enormous financial incentives for home ownership, while renters occupy a kind of second class citizenship. Mortgage brokers and other financiers understood that the social pressures to buy a home are strong, and found a way to capitalize on Americans' dreams. National policy has stacked the financial deck against renters—to then moralize about irresponsible financial decisions in pursuit of home ownership is short-sighted.

Perhaps the most important numbers to remember in today’s situation are those registering the extreme skewness of income. According to recent analyses, in 2005, 10% of households now receive 48.5% of all income, and the top 1% has grabbed a staggering 21.8%. These numbers are approaching their 1929 peak values, extremes which many economists believe were important in prolonging the Great Depression of the 1930s.

The systemic response to rising inequality and stagnating wages and incomes has been to raise household indebtedness, particularly mortgage debt. I say "systemic response" because I think a focus on "individual choice" and "responsibility" is myopic—yes, those things play a role, but the bigger influences are how the political-economic system, as a system, is setting incentives, penalties, and pressures. To deflect what would likely have been rising middle class discontent over stagnant incomes, credit was loosened. I can't tell you how conscious the political motivation was on the part of politicians, policy-makers and Wall Street, but I suspect there has been some understanding of this.

Of course, this does not mean that households shouldn’t try and resist the structural pressures to indebtedness and protect themselves to the extent that they can. The calculus of rent vs. buy changed with the housing price bubble, making ownership far more expensive as prices rose. Homes may well be a depreciating asset in coming years. Avoiding taking on unnecessary debt is especially prudent in downturns. People know this and typically debt falls when hard times hit. I’m hardly alone in expecting the current recession to be longer and deeper than the relatively mild downturns of the last two decades. In times like this, people return to basics, with more do-it-yourself provisioning, old fashioned activities and pleasures, and more frugal management of food, apparel, other consumer goods, and of course money. Friendship and sociability, "goods" which has been in very short supply in recent years, are one of the financially cheapest, yet most satisfying things we can "acquire."

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