Financial Crisis There Are Signs

Financial Crisis

There are signs that the ongoing financial crisis is coming to an end. The GDP has risen in each of the last two quarters, housing prices has stabilized, the Dow Jones Industrial Index is back above 10,000 and the White House has returned to its usual policy of excusing executive excess. Yet America is not breathing easy. Unemployment sits at 9.7% for January 2010, a historically high figure. Janny Scott and David Leonhardt argue that the class divide in the United States is growing larger. The class divide may not be driven by heredity, but it still exists. The more privileged classes in our society succeed where others fail because they are able to master the "new ways of transmitting advantage." They game the education system, getting their children access to the best public schools, thereby setting their offspring on a path in which they will be best prepared for adult success. They gain better access to health care. They ensure that the laws and tax policies support their agenda, rather than that of another group.

The financial crisis is a strong case for the continued gaming of the system in order to preserve class differences. The outcomes speak for themselves. Bankers take home millions of dollars in bonuses while millions of Americans at the lower end of the socioeconomic scale suffer unemployment and higher taxes to pay for bank bailouts. The financial crisis is a reflection, then, of how class differences continue to be a driving issue in the United States today.

Antecedents of the Crisis

A number of factors have been cited as contributing causes to the current state of the financial crisis. Among them are the housing bubble, low interest rates, bank deregulation and the bailouts. Each of these factors exemplifies in some way the class divide in the United States. The housing bubble came about in large part due to the myth of the American dream and predatory lending practices that convinced poor Americans to essentially gamble on the housing market. Low interest rates fostered an environment of free-flowing capital into the housing market, exacerbating the situation. Bank deregulation allowed the banks to take on substantial levels of risk, to the point where they required public funds to keep the banks afloat. The bailout culture in government has resulted in a situation where the taxes of a middle class suffering massive unemployment are going to the same wealthy bankers that created the unemployment in the first place.

The Housing Bubble

In the wake of the bursting of the Dot Com Bubble and the economic crisis in the wake of the 9/11 terrorist attacks, the economy was in a shambles. One sector that was still performing well at the time, however, was the housing market. Investment capital, looking for high returns, soon became funneled into the housing market, and prices began to inflate. One of the reasons for the strong demand for housing is the American dream. As Scott & Leonhardt point out, most Americans still believe in the American dream that if one works hard they can move from poverty to wealth. Home ownership is one of the most powerful symbols of American wealth -- indeed in many countries owning a nice house is a virtually unattainable luxury. In the 1950s and 60s, home ownership was relatively easy as costs were roughly in line with wages. Since that point, home values have increased at a far faster rate than have wages. In 1965, the real median household income (2007 dollars) was just below $50,000 and the real median house price was around $120,000; in 2007 the median household income was just above $50,000 but the median house price was $225,000. This disconnect should have American reevaluating their home ownership ambitions, but it has not.

Enter the predatory lenders. Subprime lending refers to lending to relatively less-qualified mortgage candidates. Risk being tied to return, these mortgages are at a higher rate. The predatory lenders utilized expanded access to subprime credit and the carrot of the American dream to dramatically increase homeownership -- something that in 2007 Federal Reserve Bank trumpeted as a success of the system. Victims of predatory lenders often did not realize that their loan rates would reset after a couple of years -- in an environment of increasing interest rates. Nor did the victims understand that they would not necessarily be able to resell their homes to cover the mortgage -- the housing market had been on a strong upward trajectory but the increasing interest rates were bringing the bubble to a close, putting many mortgages underwater. These borrowers had -- knowingly or not -- been gambling on a real estate market they did not understand. Understanding the complexities of the real estate market and fiscal policy is complicated -- those who have grown up without access to the best education and who do not have experienced friends and family to help advise them in this process were the most vulnerable.

Squires, Hyra and Renner showed that subprime lenders were able to segment their market by geography. Combined with the ethnic segregation that exists in most American cities, the outcome was simple -- minorities were targeted for subprime loans. The poor and working class were targeted by predatory lenders. When the crisis hit, it was these groups that suffered the most and foreclosure rates in these communities spiked.

Interest Rates & Bank Deregulation

To spur economic growth during the slowdown in 2000-02, the Federal Reserve lowered interest rates and implemented other measures to inject capital into the economy. This is the money that flowed into the real estate market, initiating the bubble. Banks could not find enough prime borrowers, and so increased their rate of subprime lending. They did this because deregulation of the industry had allowed them to increase their risk. The result was that banks reaped short-term rewards, but at the expense of increased risk levels. In countries that did not experience this deregulation, such as Canada and Australia, the banking system remained robust throughout the crisis and its impacts on workers were not felt as strongly. Bankers made less money, but the economy was insulated from the worst of the impacts.

Bailouts

When U.S. banks began to fail under the weight of mounting foreclosures, the government stepped in to bail them out, first the Bush administration and then the Obama administration after that. The banks expected this -- George Bush, Sr. had bailed out the industry in the wake of the savings and loan crisis so bankers knew the government would step in to protect them. Wealthy bankers gamed the system -- they gambled with money that they knew was guaranteed by the American taxpayer. In the good times, they took home tens of millions of dollars in bonuses. In the bad times, the taxpayers covered the losses. Even the bonuses, which the Obama administration initially railed against, have now become acceptable. The public, meanwhile, has seen its taxes increase and programs cut in order to help pay for these bailouts and bonuses.

Conclusion

The financial crisis exemplifies the argument that Scott and Leonhardt make about the ways in which the wealthy classes continue to find ways to press their advantage at the expense of lower social classes. Bankers well versed in economics and armed with government policies favorable to their interests flourished in an environment that promoted risk-taking. They reaped the rewards knowing that the taxpayers would pay the cost of their failure, a lesson they learned during Bush, Sr.'s pro-upper class administration.