Despite what one of my new blogging best friends thinks about the NY Times (yes, it's pretentious as hell, and totally biased, but it also has some great research), this article reminds us why we need to look at the financial industry deep and hard, instead of being sidetracked by our deep liberal hatred of the McDonald's, Starbucks and Wal*Marts of America.
The underlying problem [of the middle-class squeeze] has been building for decades. America’s median hourly wage is barely higher than it was 35 years ago, adjusted for inflation. The income of a man in his 30s is now 12 percent below that of a man his age three decades ago. Most of what’s been earned in America since then has gone to the richest 5 percent.
Yet the rich devote a smaller percentage of their earnings to buying things than the rest of us because, after all, they’re rich. They already have most of what they want. Instead of buying, and thus stimulating the American economy, the rich are more likely to invest their earnings wherever around the world they can get the highest return.
So much for trickle-down economics. Remember that brilliant theory of the Reagan era? That as the wealthy made more, the effects would trickle down through the economy as their spending stimulated the economy? As it turns out, money wasn't trickling down: it was trickling out of the pockets of the middle class, who were spending beyond their means by supporting it through credit, and then paying dearly for that credit, creating more wind-fall profits for the financiers.
The article goes on to explain how the middle class supported their life-styles:
The first way was to send more women into paid work. Most women streamed into the work force in the 1970s less because new professional opportunities opened up to them than because they had to prop up family incomes. The percentage of American working mothers with school-age children has almost doubled since 1970 — to more than 70 percent. But there’s a limit to how many mothers can maintain paying jobs.
So Americans turned to a second way of spending beyond their hourly wages. They worked more hours. The typical American now works more each year than he or she did three decades ago. Americans became veritable workaholics, putting in 350 more hours a year than the average European, more even than the notoriously industrious Japanese.
But there’s also a limit to how many hours Americans can put into work, so Americans turned to a third way of spending beyond their wages. They began to borrow. With housing prices rising briskly through the 1990s and even faster from 2002 to 2006, they turned their homes into piggy banks by refinancing home mortgages and taking out home-equity loans. But this third strategy also had a built-in limit. With the bursting of the housing bubble, the piggy banks are closing.
So why should ignore those bastard CEOs of large multi-national corporations who are earning some ridiculous multi-thousand multiple over the average employee? Because (1) the corporations themselves, besides being large, nefarious monsters devouring local businesses and culture, also support hundreds of thousands of white and blue collar workers. And I don't just mean Wal*Mart clerks or other McJobs, though, if you think about it, these are largely un-exportable jobs. There are buyers and planners, secretaries and assistants, all of whom need the pay check to support their families and have a decent life. And because (2) ultimately the CEO is one job, and if you look at the top 5 earner reporting (required) for most public companies, you'll see that after CEO, and maybe one or two other positions, the pay scale actually drops quite significantly.
Compare that to the average investment bank or, worse, hedge fund and private equity firms, where the research analysts and associates (the bottom of the ladder) take home 6-7 figure bonuses, and where a trader can make enough that he becomes one of the top 5 earners in the company.
The large financial houses have suffered some pretty heady set-backs over the past few months, and according to certain bears, there is more pain to come. But is pain really pain if (a) they caused it and (b) they all reaped millions (if not billions) of dollars now safely ensconced in trusts or overseas accounts while doing it?
The Economist writes of new research out of the University of Chicago that:
provides hard evidence that securitisation fostered "moral hazard" amongst mortgage originators, which led them to issue loans to uncreditworthy borrowers.
[For example, they found that] loans securitized by the originators or sold to non-bank financial firms [as opposed to being held in the originator's own portfolios, for example] were far more likely to end up in default. Intriguingly the study shows that there were fewer defaults than average when loans were sold to an affiliate of the originator. When the interests of originators and buyers were aligned, subsequent defaults were less likely. [emphasis mine. Gee, what a shocking result.]
A separate study [Keys, Mukherjee, Seru and Vig] also shows securitization has a lot to answer for. It finds that a loan portfolio that fits the criteria for securitization is far more likely to default than a similar package of loans with a slightly lower credit score that is less likely to be securitized.
I haven't really begun to think this whole thing through yet, though I have no doubt that the devastation from the shenanigans that the financial firms have been up to will reach far and deep. And politicians who are beholden to financial interest will never have the clarity of thought to pursue the policies necessary to put a stop to these financial machinations. Yes, John Edwards got this right. I hope whoever the democratic nominee is will revisit this issue once the primary season is over.
Up tomorrow (or whenever I get around to it): Why I love Microfinancing, or how we are taking our financial shenanigans GLOBAL (baby).
"Yet the rich devote a smaller percentage of their earnings to buying things than the rest of us because, after all, they’re rich. They already have most of what they want. Instead of buying, and thus stimulating the American economy, the rich are more likely to invest their earnings wherever around the world they can get the highest return."
The problem with this example is that is assumes that the rich were somehow born having all the material goods they'd ever need in the world. Why do they have "most of what they want"? Well, because they'd *bought* those things already. How does that make them uninvolved in the trickle-down economy? The global nature of our economy makes sure that investment in foreign or domestic companies does have a "trickle-down" effect in that invested capital gives businesses world wide the fuel they need to grow and pay employees. And that goes for foreign investment in domestic enterprises as well. I agree that white collar workers are often taken advantage of (in the number of hours worked, lack of good family benefits) and that these things need to be addressed. Also, what solution to the apparent wealth-disparity does the article suggest?
Posted by: Kate C. | February 14, 2008 at 09:23 AM
Kate,
God, I was so scared that I was actually driving people away with my paranoid rantings. Thanks for commenting.
I don't believe that the article was suggesting that they are not participating in the trickle down economy (I certainly wasn't). The way I read the article was that the trickle down effect is simply not as deep as certain policy makers might like to imply.
Also, although I agree that there is the broader trickle down effect as capital flows out to foreign countries (and I am actually probably more in favor of globalization than most Americans), the benefits/detriments of this varies depends on what issue you are addressing. If the question is American strength and economic viability, the benefits are - well - questionable. One of the problems with the outflow of individual wealth is that it is relatively easy to turn these investment into non-taxable transactions. Which means that investment gains that would otherwise be subject to capital gains tax, are not. Furthermore, the same individuals who taxlessly invest abroad (and I'm being unfair, it's not necessarily tax free, just US tax free) are the same individuals who would still expect the full support of the American government if their overseas investments were threatened (ie. by political instability, or by foreign government seizure). You could call this a form of corporate welfare.
As for foreign inflows of capital, I'm not sure where I stand on this yet. History has proven (in the Japanese case) that we have come out ahead when foreigners invest in American companies. But it does frighten me that the foreign investors, rather than buying standard mortar and brick institutions, are buying financial institutions THAT EITHER CONTROL OR ARE DEEPLY EMBEDDED WITH THE INSTITUTIONS THAT CONTROL ALL OF YOUR, MINE, AND YOUR NEXT DOOR NEIGHBORS' 401(K), PENSION PLANS, MUTUAL FUNDS and other institutial investments.
Anyways, this comment is already too long so I'll stop now. :)
Posted by: KL | February 14, 2008 at 01:45 PM