Three years ago last week, Lehman Brothers collapsed amidst a wreckage of overleveraging, over-speculation and appallingly reckless risk-taking. Lehman’s collapse sparked a financial crisis that led to rapid job loss: 3.5 million jobs were shed between September 2008 and January 2009. As the nation plunged into the “Great Recession,” the bankruptcy of thirty years of failed deregulation and supple-side economies, which gave rise to staggering inequality and a volatile financial sector, was laid naked. Three years later, it is instructive to carefully examine the lessons to be drawn from the crisis.
The primary lesson of the financial crisis is that a robust financial system cannot function without sufficient regulation. This is a lesson the U.S. already learned the hard way. The immediate causes of the 2008 crisis — overleveraging, speculation, and excessive risk-taking — are the same that caused the crash of October 1929. Then, the Roosevelt Administration implemented reforms to ensure that a functional capital market was not overtaken by a winner-take-all orgy of speculation. Most prominently, the Glass-Steagall Act insured commercial banks through the Federal Deposit Insurance Corporation, while separating them from riskier investment banking.
For nearly fifty years, this regulatory structure worked: there was no financial crisis between 1933 and 1987. Unfortunately, the haste to find new comparative advantage in light of declining manufacturing led to a reckless deregulatory campaign. Between 1980 and 1999, bipartisan deregulation loosened rules on bank mergers, interest rates, savings and loans associations, mortgage lending, and commercial and investment bank ties. With each new deregulatory act, financial markets became more volatile. The Savings and Loans Crisis of 1987 was followed by the more intense stock market plummet of 2001, itself a mere blip compared to that of 2008. Yet at each step — until the 2008 crisis, when Democrats tepidly raised their nervous hands to voice the foreign notion of regulation — both Republicans and Democrats vociferously advocated more deregulation.
In part, this was due to the growing political influence of the financial sector. Before deregulation mania, the financial sector accounted for roughly 2% of corporate profits. By 2008, that figure was a shocking 40%. In a political system with few institutional barriers to prevent the influence of money — which can be donated to candidates, parties, political action committees, used to fund independent advertisements or think tanks that advocate policies in the donor’s interest — the growth of the financial sector meant that it increasingly set the terms of its own regulation.
The second lesson of the crisis is that excessive income inequality is incompatible with sustainable economic growth. Political dialogues on income inequality usually revolve around normative conceptions of “fairness,” but extreme inequality creates economic problems that should be analyzed through a non-normative lens. Economies grow when wages rise with productivity, allowing middle and low-income workers to buy the products they produce, thereby incentivizing further production. When wages fall behind productivity — as has happened in the U.S. since 1975 — demand falls, production drops, and jobs are lost.
This is what happened in the United States: real median income has been stagnant since 1975, while that of the top 1% has increased eleven-fold. This is for three reasons. First, manufacturing (which created a large number of middle income jobs) has been replaced by finance (which creates a small number of high-paying jobs). Second, the U.S. has failed to compensate unskilled workers hurt by international trade, which, while a net good, has almost exclusively benefitted skilled workers. Finally, anti-labor policies have crippled organized labor, the historical representative of middle and low-income Americans. While 35% of private sector workers were unionized in 1975, only 7% are today. Consequently, our economic structures have been skewed toward the wealthy. This is easily observable in distribution pattern of the past decade, when 65% of income growth went to 1% of the population.
Again, the unsustainability of income inequality is not new. Throughout the 1920s, as the progressive movement and organized labor lost influence, wages fell behind productivity. Income, concentrated in the hands of the wealthiest 1-2%, was saved at higher rates, and pushed into a stock market that created ever more risky speculatory devices. Then, on a fateful fall day, the bubble burst. Sound familiar?
My favorite nursery rhyme is Yon Yonson. It goes like this: “My name is Yon Yonson/I come from Wisconsin/I work in a lumber yard there/Everyone that I meet/When I walk down the street/Asks me my name and I say/My name is Yon Yonson/I live in Wisconsin…” OK, you get the point. The Great Recession in which we presently mired is simply another line in the recursive history of financial crises whose causes we already understand. Even before this crisis, we knew that financial markets needed sufficient regulation, that finance cannot constitute 40% of an economy, that political influence should not correspond to economic might, and that an economy that benefits only 1% of the population is ultimately unsustainable.
The real question is whether our political institutions can respond constructively to the present crisis. As disastrous as the Great Depression was, it served as an important period of reflection and reform from which the United States emerged a more prosperous, more egalitarian society.
Whether the lessons of the Great Recession can be translated into paradigmatic shifts in public policy is the central question of our time, the answer to which will reflect the strength of our democratic institutions. It is to this question that I will turn next week.
Sam Sussman is a junior. He can be reached at email@example.com.