Looking for Someone to Blame
The Great Recession Explained
One of the platitudes since the Great Recession unravelled in 2008 has been to blame greedy bankers for the near destruction of Western economies. This arbitrary allocation of culpability implies that if the bankers were punished and removed from their jobs, then the economic universe would rebalance itself.
Unfortunately, the foolish behaviour of bankers and the brilliantly myopic slogan from the Occupy Movement, “We are the 99 per cent” against the “1 per cent”, do little to explain the complexities which caused the rupturing of Western capitalism.
In many ways, economics is in an intellectual crisis. Economists have had to admit that they cannot explain how the economy shapes the behaviour of individuals, societies and institutions as much as they thought.
The recessions in the United States, the United Kingdom and, in a wider context, the European Union are all interconnected, yet distinct in their own patterns, which makes it impossible to find a single answer and solution to the economic problems facing the world.
Wall Street Goes for Broke
Raghuram Rajan provides one of the best explanations for the US recession in his book Faultlines.
Rajan identified four problems and four responses to those problems that severely harmed the US economy.
The First Problem – deepening inequality
Highly skilled and educated workers in white collar jobs are being further and further set apart from the low skilled workers with little education and few career prospects. In many ways, the middle class in the US has shrunk, giving way to a small but prominent rich-class and a large and increasingly more desperate underclass. The difference in living standards between those at the top of the pyramid and those at the bottom has become dramatically pronounced.
This leads to a lack of consumption. Consumption and spending are signs of a robust economy. If people spend money, it shows that they have disposable income and the confidence to spend it. If people are not spending money, it suggests that they are worried about their finances.
The Second Problem – the “American Dream”
As we know, much of the “anyone can do anything if they just try hard enough” component of the “American Dream” is fantastical and unrealistic. There are plenty of people working their fingers to the bone without ever becoming successful and it is rarely because they aren’t trying hard enough. It has more to do with lack of access to education and opportunities – a State issue rather than a personal one.
Adding to this, in recent years, home ownership has become part of the “Dream”. It is a perceived marker of success and of having “made it”. Unfortunately, though, with increased inequality, the prospect of homeownership for many Americans has decreased.
The Third Problem – policy makers
Getting a mortgage is a large financial commitment and a major source of consumption in the US economy. If people are not able to buy homes, it means there is less spending in the economy.
Therefore, politicians who encourage homeownership can gain votes and increase consumption and make the economy appear, at least on the surface, healthier than it actually is.
Consequently, US policymakers responded to the inequality in the wrong way. They avoided tough political choices on tax and spending. In the short and long-term, US politicians did not raise taxes, expand the welfare state, invest in education or encourage people to control their finances.
Instead, they went for the easy “solution” and spurred economic growth through heightened levels of home ownership, fuelled by massive debt. This is did nothing to tackle the underlying problems, caused by poor education, low wages and a lack of social mobility.
To make home ownership accessible for people with small incomes, the Federal Reserve set low interest rates, encouraging people to borrow money. In other words, people without a sufficient salary and means to buy a property were allowed to fulfil their dreams of home ownership by taking on loans that, ultimately, they would never be able to pay back.
The massive commercial banks that gave these loans to poor consumers believed the “collateral” or mortgages, which these poor clients took on, were underpinned by the expensive houses they were buying.
In other words, the banks assumed that if people could not pay their mortgages, they would be able to seize the houses of people that defaulted.
Unfortunately, the banks made a profound miscalculation. House prices were grotesquely inflated. The value of the assets they could seize if their clients defaulted was actually far less than the loans they had made.
The Fourth Problem – precarious loans
The financial industry was and is devoted to profit, even if it gives money to dubious customers. The loans that banks gave were dangerous, short term and even self-defeating.
Bankers bundled mortgages together in complex “financial instruments” called collateralised debt obligations (CDOs), which were sold to investors who thought they had invested in decent assets when the opposite was the case.
In other words, they bundled things together in order to camouflage the precarious mortgages in order to, effectively, pull the wool over investors’ eyes.
This problem was then added to by rating agencies that declared these mortgages relatively risk-free. Why the ratings agencies defined these mortgages as Triple AAA (the top credit rating) is still hard to explain. To put it simply, the rating agencies were either being underhanded or incredibly stupid.
Thanks to the healthy (but false) credit ratings and the camouflage that the CDOs offered, the financial sector were then able to trade in these toxic mortgages, vastly expanding the already problematic and unstable housing bubble.
The reason that many US voters became so infuriated with the bankers is that it was the bankers who made these ill-advised CDOs deals and, due to immense short-sightedness, caused huge damage, yet still became rich.
As we have seen though, the bankers certainly are not the only ones who should be receiving blame – they tried to profit from a poor situation created by unwise decision and policy-makers, as well as a longstanding culture that has made material wealth and property ownership the clearest marker of success.
Two Banks in the UK
Obviously, the financial connection between the UK and the US is enormous. The economy in Britain, therefore, immediately suffered as a result of the situation in America.
It is important to point out, though, that Britain is also to blame for their own economic situation. Two of the UK’s biggest banks, the Royal Bank of Scotland and the Halifax Bank of Scotland, had to be saved by the taxpayer. These two banks were guilty of bad mismanagement, in that they provided bad loans and they allowed themselves to be heavily exposed to the US mortgage crisis, making poor financial decisions because of it.
The UK economy subsequently shrunk by a considerable margin and unemployment rocketed. It appears to have peaked at around 2.5 million people and a rate of around 8 per cent. Since then, the UK has been subjected to a recession much severer than people expected and a recovery much slower than anyone would have hoped.
Attempts to stimulate the economy through quantitative easing (printing money) and encouragement by the Bank of England to get commercial banks to lend money to entrepreneurs and support businesses have been ineffective. There have also been intense debates about how to regulate the banks, cut the UK’s gigantic debt pile, while finding a way to restart an economy that has found itself in a position where everyone who would usually spend money, either in the public or private sectors, does not want to.
Even worse for Britain, is that it is on the doorstep of the worst economic disaster in the world. The economic situation in the Eurpean Union is precarious at best, denting the chances of a sustained recovery in Britain.
Finally, George Osborne, who is the UK’s finance minister, has frequently said the UK can export its way out of trouble. However, consumers on the continent do not want to buy UK goods while their economies are so fragile.
Europe is the greatest threat to itself
In Europe, the economic predicament is even more desperate than in the US and UK, as it has been worsened by a political tensions. Countries such as Spain, Ireland and Greece had similar problems to the US. These nations had colossal sums of debt and an economy that was based on a housing bubble which burst spectacularly.
Compounding these issues is the political structure of the Eurozone – it has a single currency area that is very fragmented. It has a central bank and monetary union, but no political or fiscal union. This means that the decision making process is not only tortuous, due to a lack of centralisation, but it is also seen as undemocratic.
In an economic system there must be a mechanism of unified tax and spending, especially in recession, where those in power must move rapidly to soften the impact of economic downturns. In Europe, the speed of crisis management has been tepid.
Also, there is a discrepancy between the competitive northern European nations of Germany, Finland and the Netherlands, which have first-rate economies that are productive and which have the rule of law. Meanwhile, the states in southern Europe are not as strong on these two fronts, providing for disunity between the north and the south.
Recently, European leaders have worked hard to bring closer integration and harmony to the Eurozone. One of the temporary solutions the EU has announced is that the European Central Bank will be prepared to ease the borrowing costs of heavily indebted nations like Spain and Greece. For the time being, Europe’s problems have receded from view but they could flare up at any time.
On a wider front, the developed world has built up debts which it has not figured out how to pay off yet. The level of debt affects everything from government spending to unemployment rates and peoples’ standard of life. The answer to the question of debt is the definitive task of our generation.
Words: Michael Klimes
Featured Image: Feral78