This blog is the conclusion of The Great Depression and the Great Recession (1) in which we consider two articles which compare and contrast the 20th Century’s Great Depression with the 21st Century’s Great Recession. In this blog we are looking at “The Debt Bomb” by Louis Hyman from the Winter 2012 edition of the WILSON QUARTERLY. Hyman sets the scenario:
“In the last hundred years, economic inequality in America has peaked twice: in 1928 and in 2007. It is no coincidence that our periods of greatest inequality have coincided with excessive lending. An industrial economy based on mass production requires mass consumption. Either credit or wages must be provided to keep the wheels of industry turning. When wages stagnate and inequality widens, debt gains nearly unstoppable momentum.”
The Great Depression came to an end during WWII after which there was a great economic boom in America and other parts of the world.
“Living in mortgaged homes, driving in financed cars, postwar Americans relaxed at new shopping centers. They borrowed more but also earned more, which meant that while the habit of borrowing grew, debt as a share of income remained relatively stable. Consumer credit kept factories humming, and those well-paid industrial jobs kept the debt burden contained. Banks and finance companies rather than capital markets funded the borrowing, which kept a leash on the credit available. The lender always had skin in the game.
The origins of the shift from a relatively egalitarian manufacturing economy to an unequal financial economy can be seen in the midst of this prosperity.”
The boom, as history has shown in capitalist countries is only part of a cycle which also has a down side. The prosperity following WWII changed as “…consumers also began to rely more on borrowing to make ends meet. The careful balance between rising debt and rising income was coming undone.”
The modern American economy began to shift away from manufacturing and more toward profit making through financing – investing and lending which tempted people with potential huge profits over short periods of time.
“As profits in other parts of the economy receded, the profits of this kind of lending exploded. And as consumer debt began to crowd out business debt, less money was available to invest in productive businesses and create the kinds of good jobs that had made America’s postwar formula work.”
“When Jack Welch took the helm at General Electric in 1981, largely on the strength of his success in managing the company’s consumer finance division, his vision was clear, he would later write: ‘Finance is not an institution—it has to be . . . the driving force behind making General Electric ‘the most competitive enterprise on earth.”’ Some older divisions, such as the lighting operations, would be continued, but the profits would be reinvested in financial products.”
“While GE’s profits grew, its manufacturing businesses shrank. In 1980, the year before Welch took control, the company had employed 285,000 people in the United States. By 1998, the U.S. payroll was down to 165,000. For Welch, and for successful American corporations generally, profits mattered more than all those well-paid factory jobs. The incentive was plain. CEOs had a responsibility to the shareholders to produce more profit. A dollar invested in debt made more money than a dollar invested in a factory. For the country as a whole, however, the rising profitability of finance came at a devastating cost.
As finance gained in strength and in its importance to the American economy, bankers increasingly complained that their creativity was being hampered by those pesky regulations that had safeguarded the economy since the 1930s.”
To me what Hyman is portraying is that manufacturing creates jobs that pay well and thus prosperity is spread to a great number of people (the workforce). On the other hand, the movement in an economy to becoming increasingly based in financial products reduces the workforce thus causing a loss in good paying jobs and concentrating wealth in the few. The effects on the nation’s economic well being is negative – as was seen in the 1928 and 2007, both years in which the American capitalistic economy collapsed.
“Contrary to what many politicians and pundits have claimed, the upsurge of securitization was not simply a product of ‘deregulation.’ Regulations may have changed to promote a certain kind of financial system, but at no point did the state abandon the market to itself. It was the interplay of public and private purposes and mechanisms—Freddie Mac, S&Ls, mortgage-backed securities—that made these new sources of capital possible.”
Hyman offers a warning that there are lessons to be learned, or history will simply repeat itself.
“That structural connection between economic inequality and the nation’s financial crisis is still largely ignored. The dangerous investment choices that precipitated the crisis are but a symptom of this underlying cause. Income stagnation continues, pushing Americans toward greater borrowing and less saving. Unemployment remains extraordinarily high. And those who do find work often have to accept lower wages.
Meanwhile, as those at the bottom hang on, profits continue to concentrate at the top. Without a good alternative, capital continues to be invested in consumer debt rather than in the businesses—big and small—that provide jobs. Bankers are once again skittish about lending. If we are to find solutions to the crisis, it is more important to ask why so much money flowed into mortgage-backed securities and so little into productive businesses than to search for villains to blame for what went wrong.
During the Great Depression, New Deal policymakers figured out ways to harness the resale of debt, but they recognized that increasing the supply of credit without also increasing wages would only lead to another crash. But in the last 40 years, debt levels have climbed while wages have remained stagnant because securitization made it much easier to lend to consumers than to businesses. That continuing imbalance is a threat to the long-run stability of the American economy.”