It’s Not Capitalism Anymore, and someone has noticed

Middle Class photo

Jim Tankersley has a series of articles published in the Washington Post which ought to do for Wall Street what Dana Priest and Ann Hull did for the Walter Reed Army Hospital and other veterans’ care centers in previous publications – expose problems at the core of the institution.

“In 2012, economists at the International Monetary Fund analyzed data across years and countries and concluded that in some countries, including America, the financial sector had grown so large that it was slowing economic growth. Using a different methodology, the most prominent researcher on the size and economic value of Wall Street, a New York University economist named Thomas Philippon, estimates that the United States is sinking nearly $300 billion too much annually into finance.” [WaPo]

How could this be? Isn’t the financial sector supposed to be the heart pumping capital through the veins of American enterprise? That would be capitalism, in which money saved (surplus) is channeled into investment (scarcity) and the machine moves smoothly.  What happened?  We’ve heard this before, from those economists who decry the inflation of the financial sector – that the firms (banks) are more interested in devising financial products for their own profit than they are in acting as brokers for financial markets between business and finance.  The result is a drain:

“In perhaps the starkest illustration, economists from Harvard University and the University of Chicago wrote in a recent paper that every dollar a worker earns in a research field spills over to make the economy $5 better off. Every dollar a similar worker earns in finance comes with a drain, making the economy 60 cents worse off.”  [WaPo]

Compounding the problem we have a consumer culture and institutional environment which abet this drain.  In a good old fashioned Capitalist system the financial sector is concerned with creating markets for investment, again that’s moving money (capital) from savings to scarcity.  However, when the financial sector changes function to moving money from scarcity (debt) to revenue for the firm the investment firm (bank) does well but the underpinnings of the economy are weakened.

Savings Rate

We’ve been keeping track of the personal savings rate since 1959.  Notice the general direction of the trend line since 1980.  The ratio of  personal income saved to our personal net disposable income has been tightening. We are, as a nation, saving less than we saved in the decades before 1980.  And, we’re accumulating more debt:

Household Debt trends

Note, again, that the accumulated liability for consumer debts started pulling up in the 1970s and 1980s.  When the savings rate is trending down and the household debt level is trending up how are the bankers and financiers to make money?

Debt is inherently risky.  So, securitize the debt and spread it around. And earn fees for the bank in the process.  In 1970 Ginnie Mae launched the first securitized mortgages, and in 1985 Wall Street securitized the first auto loans.  This situation expanded to include the packaging of credit card backed securities, home equity backed securities, collateralized debt obligations, student loan backed securities, equipment lease backed securities, manufactured housing backed securities, small business loans, and aircraft leases.

Once more with even more feeling: One man’s debt is another man’s asset. Now, one man’s debt can be magically transformed into the assets of several investors.  As long as Americans are willing to accumulate more and more indebtedness, the bankers will be equally willing to create “financial products” to securitize that debt and make money doing so.  The consumer culture and the institutions that profit from all the mortgages, auto loans, credit cards, student loans…. works perfectly well for the financialists.  Gone are the days when savings formed the basis for the health and wealth of Wall Street. Now it’s debt.  And, the corollary of debt: We have put about $300 billion per year too much into the Wall Street Casino.

Even our tax system permits this situation – we tax capital gains at 15% and productive work at levels above that. We have loopholes aplenty for writing off debts incurred by major corporations. We have a tax structure which depreciates work and products while appreciating financial products. If this isn’t bad enough, we’ve based the system on some very tentative valuations.

What is the “fair value” of any package of securitized assets?  This is not only an accounting problem. It’s also an issue for accountants.  [GSBColumbiaEdu pdf]  It’s also an issue for homebuyers who are now being told that the down-payment standards could be reduced to 3%. [MortgageNews]  What do the mortgage lenders want?  Their strategic goal:

“Maintain, in a safe and sound manner, foreclosure prevention activities and credit availability for new and refinanced mortgages to foster liquid, efficient, competitive and resilient national housing finance markets.”

What does Wall Street hear?  More people taking out more mortgages, which can be diced and sliced, warehoused, tranched into pieces, and sold as securitized asset based financial products.  So, what IS the value of one of these products?  After the Housing Bubble Debacle of 2007-08 the Federal Reserve created the Term Asset-Backed Securities Loan Facility which was supposed to help untangle the mess made by the Wall Street Casino.  Two new acronyms entered the financial vocabulary – TALF and CMBS (non-mortgage securities).  When the Office Monetary Policy studied the results of the program it found:

“In terms of benefits, the results point to substantially stronger effects at the market level than at the security level, which suggests that the impact of TALF may have been to calm investors, broadly speaking, about U.S. ABS markets, rather than to subsidize or certify the particular securities that were funded by the program.” [Campbell pdf] 

Okay, the investors felt better, more comfortable, and the government wasn’t at great risk, that’s the good news.  The bad news is that despite the best efforts of algorithm creating quants – there is still no valuation of ABS (asset based securities) which goes much beyond “what they’re worth is what someone is willing to pay.”  From the Campbell Study: “In addition, we find that the program screened out the riskiest deals but attracted somewhat riskier than average deals among the pool of potentially eligible securities.”

Thus we find ourselves with a tax structure which rewards investment gains over productive work, an investment system that rewards the sale of financial products derived from indebtedness, and banking institutions which make investors “more comfortable.” Top this off with  a population far more willing to spend than to save and there’s all manner of potential for yet another Casino Bust.

When does the indebtedness become unsustainable?  In order to create all the ‘wonderful’ products on Wall Street someone has to buy a house, purchase a car, take out a student loan, put items of the household credit card, lease some heavy equipment, lease an aircraft, take out a small business loan, or in some other way accumulate debt which can be transformed into an “asset.” What happens when the stagnation of wages becomes such that there is no more room in the family budget for more debt?

For most workers in the United States their wages haven’t moved significantly for decades.  In the old fashioned Capitalism vernacular, when labor markets tighten, wages will go up.  However, this hasn’t been the case for years. [HuffPo]

“… after adjusting for inflation, today’s average hourly wage has just about the same purchasing power as it did in 1979, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms the average wage peaked more than 40 years ago: The $4.03-an-hour rate recorded in January 1973 has the same purchasing power as $22.41 would today.” [HuffPo] [BLS]

Not to be a complete Grinch in the midst of everyone’s Christmas season, but to suggest that either savings or indebtedness (or both) can sustain a long term healthy growth rate in the U.S. economy is pure lunacy, unless wages and salaries make some significant gains.  Arguing that “we can’t afford” to increase the minimum wage because we’ll be “non-competitive” in world markets is essentially contending that it’s somehow better to risk ending up being nothing. 

The BLS report for December 2013 shows an average hourly wage of $20.35, and an estimated average hourly wage of $$20.74 for 2014.  Both of these numbers show less purchasing power than the January 1973 average hourly wage.  In the long view: Less purchasing power = fewer purchases = less indebtedness for large expenses = fewer asset based securities = less income for financiers, who for the moment give every appearance of believing that short term gains are preferable to long term losses.

If anyone is arguing that the income gap doesn’t really matter, and perhaps it’s just that some people are better at earning than others – and we shouldn’t punish success, then we ought to take a second look at what this philosophical perspective means for long term economic growth.

Income Gap

When more income is siphoned off toward the upper income earners, and the gap continues to expand, the obvious conclusion is that those who earn middle incomes are less likely to … and here we go again … spend money, have disposable income to spend, have the capacity to take out loans and mortgages…  For those who prefer numbers to charts, the Census Bureau has handy downloads.  In 1967 the top 5% had an aggregate of 17.2% of the nation’s income, and the middle category had 17.3%.  As of 2013 the top 5% had 22.2% and the middle category had 14.4%. (Table H2)

How is it possible to sustain, much less grow, an economy in which larger accumulations of income are consistently moving into the hands of fewer consumers?  It may be fine (for the financiers) for families to take on more debt to sustain a middle class lifestyle in the short run, but eventually the pinch has to be felt by the financialists who are benefiting from the situation.

It almost seems as if we have a financial system which has turned old fashioned Capitalism on its head – savings bad, spending good, indebtedness better; a financial system that is feeding off the debts of people who have less capacity to even become indebted as time moves on.  Instead of a vision of Capitalism writ large, we’ve settled for a myopic view of short term gains to satisfy an investor class moving ever so steadily away from the realities of our economic life.

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