So we can’t adequately explain what happened with either the long view of
human nature or with a close‐up on the finance sector in recent years. Nor
should we overstate the importance of a handful of now retired operators. The
crisis we now face begins to form in outline in the early seventies. Two related
developments introduced growing instability into financial markets and the
wider economy – the growth of debt and the deregulation of finance.
After a long period of expansion between 1945 and 1970, in which real wages
grew steadily throughout the developed world, workers’ compensation levelled
off. Average earnings per hour in private non‐agricultural industries in the
United States reached $8.99 in 1972 (calculated in 1982 dollars). By 2007 they
had risen to $8.30. Sorry, no, they had fallen to $8.30 (again, calculated in 1982
dollars).16 More widely, in the rich, industrialised world, the percentage of GDP
captured by all workers in the form of wages fell from 75% in the mid‐seventies
to 66% in the middle years of this decade.17
Output per hour continued to rise – workers still produced more goods and
delivered more services, helped in part by information technology. But they
weren’t being paid more in real terms for the time and effort.
So who benefited from the weakening share of income secured by labour? Profits
and rents have increased by a full third over the last generation, so the first
group to benefit from the shift was the very, very rich. The result has been a new
Gilded Age, reminiscent of the late nineteenth and early twentieth centuries,
with all the exquisite good taste, state of the art sycophancy, and imperial
violence that characterised the earlier era.
But the share of GDP paid to workers was also distributed far more unevenly.
Managers who successfully drove down wages for the rest of the workforce
themselves enjoyed massive increases in wealth. According to Paul Krugman, in
1970 American CEOs made $1.3 million a year ‐ 39 times as much as the average
worker. By 1999 their pay had increased to $37.5 million ‐ a staggering 1000
times the average.18
Much of the extra money came in the form of share options. The idea was that
the interest of senior management would be aligned with the interests of owners
by giving them the right to buy shares at an agreed price. So senior managers
focussed obsessively on the share price of their companies. The long term
prospects for the company, the interests of workers, anything that didn’t feature
in the quarterly numbers was left the public relations and human resources
departments. Senior management wanted, with a passion that can only be
imagined by those who make do with the more pedestrian pleasures of a weekly
or monthly paycheck, to hit the strike price on their options and so join the ranks
of the astonishingly wealthy. Wall Street and the City were on hand to press the
‘products’ (usually a euphemism for debt) that would help them. Arguably senior
executives and their financiers colluded to achieve their own short‐term goals at
the expense of inattentive or too‐trusting owners.
So, the financial sector also did extremely well in the period after 1970, in part
because of the new reliance on debt‐funded expansion in the corporate sector, in
part for reasons we will come to later.
And what were these heroic CEOs up to that made them so much more valuable
than previous generations of business managers?
Well, consider the head of Bear Stearns. In July of 2007, as defaults in the subprime
mortgage market caused two hedge funds controlled by the company to
collapse, James Cayne was out of the office for a full ten days, to honour pressing
bridge‐playing commitments. According to reports in the Wall Street Journal
Cayne spent a good part of the month in Nashville, Tennessee at a tournament.
His long‐time colleague at the firm, Warren Spector, joined him there for at least
some of the time. Spector was directly responsible for Bear Stearns Asset
Management, the division with the imploding hedge funds.
On his return to New York Cayne exercised the swift and sure judgment to be
expected of a man whose annual pay in 2006 had reached $33.9 million and
whose stake in the company had peaked in value at around $1 billion. On August
5th he fired Spector. But Cayne’s willingness to jettison his old friend came too
late to save him. He left a few months later and JP Morgan bought the company in
a fire sale in March 2008.
At Lehman Brothers the CEO, Dick Fuld, made around $45 million in the last full
year before his company collapsed. At American Insurance Group the CEO,
Martin Sullivan took home $26.7 million in 2006 and $13.9 million in the
following year. In 2008 the company collapsed.
And the problem wasn’t confined to the banks that collapsed outright or were
saved by the government or by larger competitors. Throughout the financial
services sector managers and senior staff were making vast sums on profits that
would later turn out to be a fantasy. Companies that were taking disastrous bets
in the markets for mortgage and other forms of debt were paying handsomely
for the opportunity to do so.
It wasn’t only Wall Street where huge rewards found their way to a favoured
few. The CEOs of America’s biggest car manufacturers, who appeared before the
US congress to plead for a government subsidy in 2008, had done pretty well
from the last days of Rome.
The head of General Motors, Rick Wagoner, took home a total of $14.4 million in
2007, up 40% from the previous year. As part of his pay he received $700,000 in
‘other compensation’, which paid, among other things, for corporate jets. While
its CEO was gadding about in non‐automotive forms of transport the company
posted losses of just over $38 billion in 2007. The head of Ford, Alan Mulally, also
did well from ‘other compensation’, receiving $1.4 million of it as part of a
package worth more than $22 million in total. Ford only lost $2.6 billion in 2007,
so, compared with Wagoner, Mulally looks like excellent value.
These corporate high flyers scored something of a public relations own goal
when they flew to Washington in their private jets to ask for a bailout. Second
time round they realised that it might make more sense for the heads of car
companies to drive. Paying these men tens of millions of dollars for their good
judgment turns out to be a highly effective way of undermining their capacity to
avoid farcically inappropriate behaviour.
There were some other big winners in the workforce in the years after 1970.
Professionals who made themselves useful to the business elite made good
money in the years of the debt‐fuelled upswing – lawyers, management
consultants, tax accountants.
And a few favoured niche providers also did well. Those who told camp‐fire
stories of the sort that sets the blood of financiers racing could make out like,
well, like bandits. So, for example, the very highly rated and incredibly bright
historian of finance Niall Ferguson took his share of the goodies by lecturing
hedge fund managers about the ascent of money. At the height of the mania now
past, in what he now wistfully calls ‘the glory days of 2006’, the appetite for
Ferguson’s historical musings grew so keen that he found it possible to bill as
much as $100,000 for ‘a one‐hour speech at some extravagant hedge‐fund
manager conference in an exotic location’19 ‐ you have to love that ‘exotic’.
History does not record whether Ferguson’s wisdom extended to a warning that
the glory days were fast coming to an end.
So by 2008 the majority of the workforce had seen little or no real increase in
hourly pay after nearly thirty years. A number of things helped to distract these
same workers from what was happening. For one thing a vibrant industry grew
up that insisted that inequality wasn’t growing, and dismissed any attempt to
describe reality as a kind of political extremism.
As the economist Richard Wolff explains, workers also worked more.20 The
single income household, which had been more or less the norm after 1945,
became increasingly unusual. Where one (usually male) wager earner had been
able to provide for a family of four and to increase consumption year on year,
now a more affluent style of life would only be affordable with two incomes
coming in. So women went back into the workforce in growing numbers and
children entered the workforce earlier.
The working week also grew longer ‐ more hours being needed to achieve any
increase in real buying power. In some cases one or both adults in a household
took a second job, extending hours spent working even longer. Each of these
moves helped offset the reckoning. As industry and the economy expanded,
longer hours enabled workers to consume more. Indeed longer hours
encouraged them to consume more, even forced them to do so. Women and
children who went out to work needed cars and clothes, parents needed childminders.
And all the while an ever‐higher percentage of the value created was
flowing to a favoured minority of workers and to the owners of capital.
There were only so many hours in a day and so many wage‐earners in a
household. Workers would only be able to afford to buy the goods they were
making in ever greater abundance if the could find more money from
somewhere. But where? The solution was obvious. Those who had secured a
higher share of output in the form of profits and executive pay would lend the
money they couldn’t spend themselves to the workers who wanted to enjoy
higher living standards. In other words the people in the system who liked to call
themselves winners would lend the people they liked to call losers the money
that they could no longer command as wages. From 1970 onwards levels of debt
began to rise in the United States, quite slowly at first. In 1985 total household
debt in the US reached 70% of disposable income. After 2000 debt grew at more
than 5% per year and had reached nearly 122% of disposable income by 2006.21
As in the United States British workers bridged the gap between incomes and
aspirations with borrowing. By 2005 household debt had reached a staggering
159% of disposable income.22 And by the summer of 2007 total household debt
exceeded GDP for the first time, at £1.35 trillion.23 As in the United States the
debt greatly boosted the ‘retail, entertainment and recreation’ sectors – or
‘shopping, gambling and drinking’, in Christopher Harvie’s mordant translation ‐
as well as that most potent narcotic of them all, a housing bubble.24
While it lasted the whole thing worked beautifully. Workers had more money to
spend, investors had somewhere to put their surpluses, retailers could continue
to increase imports to meet growing demand. Ambitious young politicians like
David Cameron could make some useful extra income on the boards of
companies selling ‘recreation’ to the increasingly befuddled and violent
masses.25 House prices rose, consumption increased, and everyone was an
entrepreneur, a winner.
Companies also took advantage of the opportunities afforded by credit and
borrowed to grow market share. It was all about ‘accelerating the balance sheet’
by reducing capital to a bare minimum and replacing it with debt. Assets were
sold off and leased back, key functions were outsourced and offshored; the more
vulnerable companies became, the higher their shares price climbed. Managers
who acted prudently attracted the attention of competitors and private equity
partnerships and either changed their ways or found themselves pushed aside.
And the bankers loved it, too. All the lending had to be channelled into the
pockets of borrowers and all the repayments had to be channelled back into the
pockets of investors. The financial sector’s share of total corporate profits grew
until it was double what it had been in the 1950s.26 Their profits rested on
dizzying levels of lending, of course, relative to their capital base. They had taken
on far more risk than had ever been taken on by financial institutions in the past.
But the bankers thought they didn’t have to worry. They had solved that
particular problem. They could aggregate large amounts of debt from credit
cards, personal loans or mortgages and sell them to investors in the form of
The banks were usually obliged to take the bonds back in the event of a default,
it’s true, but they could insure themselves against this eventuality with a new
form of insurance called the Credit Default Swap. They paid another institution a
premium and would receive compensation from that institution in the event of a
bond failure. The cost of insuring against default barely dented the fees the
banks were taking from investors in these debt‐backed bonds – the bonds were
rock solid, after all, and ratings agencies were on hand to give them a clean bill of
health. It looked as though the banks had found a sure‐fire way to make money
forever. Bankers stopped being merely smug, they began to move about in a
state of dazed beatification. Bankers this happy are, like stories about broom
cupboards in Knightsbridge selling for vast sums, a Sure Sign of Trouble.
Politicians liked the brand new money machine, too. They had no great appetite
for telling their electorates that the system that had delivered improved public
services and higher levels of private consumption since World War 2 had started
to fall apart.
It was as though the engine of post‐war prosperity was still moving down the
track, but the rolling stock was being broken up and used as fuel. Yes, the engine
was beginning to belch black smoke. At every station a few more passengers had
to disembark and economy class grew a little more crowded. But so what? First
class was ever more roomy and opulent, and the bar was still serving drinks.
No one wanted to hear about problems. Lenders and investors wanted more
opportunities to speculate with their capital. Corporations wanted customers for
the cornucopia of goods and services their workers around the world were
producing. Working people in Britain and the United States wanted these same
goods and services and they wanted to believe that they were rich enough to
afford them. They wanted, above all, to own their own home. True they wouldn’t
actually own the home for most of their life, but they wanted something like
security of tenure, at least.
Financiers wanted to step in to make the magic happen, bringing lenders and
borrowers together for their usual, immodest fee. Advertisers had fun telling
everyone that they were worth it, that life was for the living, and that
consumption, when seen in the right light, was really a kind of investment – after
all, wouldn’t the right dress, the right car, or the right deodorant bring us all we
longed for? Didn’t self‐restraint amount to a kind of self‐harm, by depriving us of
the chance to be really and truly, finally happy? And this is not about berating the
feckless poor for their appetite for ghastly trinkets and noisy electronics. The
educated middle classes reliably fell for the sales pitches intended for them – all
that reclaimed and sustainably produced stuff.
It felt like boom time for everyone. The cruel unfairness of life at last seemed to
have been set aside. Debt had made us all equal, no matter what we earned. We
all could afford the good life, all of us could live like we were famous, or at least
like we were well paid.
Houses became a source of buying power on an unprecedented scale. In Britain
‘housing equity withdrawal’ funded the acquisition of high cost items like cars.
But the money didn’t only go to on luxuries. According to Susan Smith, a housing
expert at Durham University this borrowing became ‘a form of self‐administered
welfare payment’. Homeowners used the money ‘to support children, smooth
over a fall in income or meet the costs of a relationship breakdown’. Long hours
were taking their toll.
Stocks, real estate and all kinds of property rocketed in value between 1980 and
2007. As we have already noted, those who started out owning these assets
needed only to hold on them to see their wealth explode. The most energetic, the
most ruthless and the most skilled joined the party, seizing an ever‐larger slice of
income. A few people got lucky; lotteries and talent shows fed on, and made
more potent, the dream of sudden, life‐changing wealth and fame. They worked a
profound transformation on a culture where real opportunities were contracting
for many, to be replaced by spectacular repetitions of fairy tale narratives.
It’s true that global growth wasn’t exactly spectacular, averaging only 0.7% in
the period after 1980. But since the rich secured a vastly disproportionate share
of that growth, why would they want to complain?
Unfortunately there was a bigger problem than sluggish growth. It was obvious
to anyone who managed to think clearly for a second in the midst of the noisy
calls to borrow and spend more. It is so obvious in retrospect that the reporting
classes must now use every ounce of their ingenuity and skill to keep it under
wraps with talk about derivatives and market failure. At a certain point – it was
never clear exactly when – the levels of indebtedness would become
unsustainable. That is, at a certain point the borrowers and the lenders would
blink, since the levels of debt could not rise indefinitely.
But if the levels of debt stabilised then economic growth wouldn’t simply level
off with it. Opportunities to invest would disappear. Without fresh transfusions
of credit consumers would start to wonder how they were going to pay off what
they already owed. The tensions built up by growing income inequality would no
longer be eased by the wonders of novel consumption. Large numbers of jobs in
retail and leisure depended on debt‐funded consumption, so the end of credit
expansion would lead to steeply higher unemployment. Workers would wonder
why, in a world transformed by modern technology, they had to work such long
hours and why they could afford so little.
The debt problem became even more acute in the context of the speculative
bubble in housing. Wage earners were taking out ever‐larger mortgages in the
expectation that house prices would continue to rise. And that seemed fine as
long as they did continue to rise. But prices couldn’t rise forever. Once house
prices stalled the lure of higher prices vanished. Without rising prices few in
their right minds wanted – or were able ‐ to pay the going rate and house prices
started to fall steeply.
Lenders and borrowers moved to reduce the levels of debt further and
as they did so, demand was sucked out of the economy. In the final quarter of
2006 British homeowners had borrowed £14.5 billion against the supposedly
higher values of their homes. In the full year housing equity withdrawal was
worth more than £49 billion.27 But in 2007 it fell to £41 billion28 and in 2008 it
collapsed into negative figures as homeowners moved at last to reduce their
debts and lenders stopped giving them more money.29 Without the wealth effect
of higher notional house prices, and the readies made available by secured
borrowing, demand slumped.
In Britain the result is a sharp contraction in economic output, compounded by
the problems in the financial sector. The banks have handed out huge sums
secured against property that is falling in value. As more businesses and
individuals default the banks face ever higher losses from their conventional
lending and from their entanglement in the derivatives markets. The unwinding
of the credit boom in the United States is threatening to derail a global economy
dangerously reliant on the Americans’ willingness to borrow and spend. Interest
rates have been cut steeply in both countries, but the debt burden remains.
This then was the accident waiting to happen – debt was deployed as the
solution to flat buying power. Debt counteracted the effects of stagnant real
wages for as long as it expanded. As a result economies could continue to grow
even as they grew more unequal. Notional gains in asset wealth encouraged
workers to borrow ever more money.
So there was only one problem with the organization of political economy in the
period after 1970; it was always, eventually, going to end in disaster. Other than
that it was a great idea.
Is it really that simple? Isn’t it something to do with the unfathomable
complexity of modern finance? At best all that stuff adds some useful detail, and
explains how bankers contrived to make the upswing of credit expansion more
lucrative for themselves. But at worse it is the patter of a close‐up magician,
something to take mind and eye off the really key part of the trick. God knows
the banking sector will have to be reformed, but a narrow emphasis on
misplaced ingenuity will leave us unable to avert another crisis brought about by
the flat buying power of the majority.
Borrowers and lenders both played their part in the farce that is now becoming a
tragedy. But it won’t do to wax all philosophical about the vagaries of human
nature. Our political and economic leaders assured us at every step that all was
well. At times of national emergency they went so far as to encourage back into
the shops. I know that Bush is yesterday’s man and that ding dong the witch is
dead, but it remains the case that the President of the United States responded to
the terrorist attacks of September 2001 by insisting that ‘we cannot let the
terrorists achieve the objective of frightening our nation to the point where we
don’t conduct business, where people don’t shop’. It wasn’t the prudent
acquisition of life’s necessities that concerned Bush, but the orgy of unreflecting
acquisition on which his country’s economy increasingly relied.
As the housing boom picked up families that wanted even a modicum of security
had little choice but to take on vast mortgages. And again the lenders – and the
political leadership ‐ were on hand to assure them that there was no danger.
Things are going to get bad enough without the heavily indebted majority
shouldering a disproportionate share of the blame.
Next: Alright, the deeper cause of the crisis
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