Most of Us Will Not Have a Better Life Unless We Turn the Tables on the Super Rich
The following is an excerpt from 99 to 1: How Wealth Inequality Is Wrecking the World and What We Can Do About It, by Chuck Collins (Berrett-Koehler, 2012).
An economy so dependent on the spending of a few is also prone to great booms and busts. The rich splurge and speculate when their savings are doing well. But when the values of their assets tumble, they pull back. That can lead to wild gyrations. Sound familiar? It’s no mere coincidence that over the last century the top earners’ share of the nation’s total income peaked in 1928 and 2007—the two years just preceding the biggest downturns. —Robert Reich (b. 1946)
There are many theories about what triggered the 2008 economic meltdown. These explanations focus on bad actors such as the large banks and financial firms, the unregulated “shadow” financial sector, and unethical subprime mortgage pushers.
But there is a missing lens to the story, one that shows how the economic meltdown was caused by excessive income and wealth inequality. The two triggers were consumption by the 99 percent based on borrowing rather than real wage growth, and reckless financial speculation by the 1 percent.
Ingredient 1: Consumption Based on Borrowing, Not Real Wage Growth
Real wages for the bottom 80 percent of households have remained relatively stagnant since the late 1970s. People survived these stagnant wages by working more hours, bringing more family members into the paid labor force, and borrowing more, thanks to easy access to credit. This put enormous stresses on many working families as they got caught on a work-consume-borrow treadmill. But for many, this was the only way to attain or maintain a middle-class standard of living.
Most households stopped being able to save. In 1980, the savings rate—the share of people’s income saved after expenses—was 11 percent. By 2007, the U.S. savings rate had plummeted to less than 2 percent, meaning people were earning only slightly more than they were spending.
Did things appear different? With a median income of roughly $50,000, many people in the United States were living with little surplus. That said, the parking lots at the mall and the Applebee’s restaurant were full. The rising middle class bought new cars, teenagers got smartphones, and families took expensive vacations. These feats of consumption were not a reflection of rising wages. In some cases, increased spending was the result of two or three incomes. But most purchasing was made possible by families taking on more debt. Consumer debt—both credit card and home equity loans—escalated during the decade prior to 2008. The total amount of credit card debt exploded, thanks in part to aggressive “debt pushing.” In 2006, there were 6 billion credit card solicitations sent out.The majority of home financing was for second mortgages, not new home acquisitions. Access to easy credit was the drug that enabled millions to live beyond their means.
Exploding consumer debt was worsened by a shift in the culture, as extensive borrowing became more socially sanctioned. The debt pushers contributed to this, advertising cheap credit and peddling home equity loans as the new normal.
Overwork and debt masked the reality of falling and stagnant wages. If you and your neighbors could still acquire a flat-screen TV and take a Caribbean vacation, then it was hard to feel constrained. But these trends were fundamentally unstable. Underlying these indicators was a growing credit card and housing mortgage bubble. Think of the sound track from the movie Jaws as a shark creeps up on the unsuspecting swimmer.
The entire economy was humming, but it wasn’t based on healthy wage growth and shared prosperity. The consumption engine driving the economic boom between 2000 and 2008 was based on borrowing, not real wage increases.
So when the economy seized up in 2008 and access to easy credit ground to a halt, so did the consumption engine. Millions of people lost their jobs or a significant household income. But they also lost the borrowing lifeline that had eased the gap between inadequate income and spending. Without debt-driven consumer demand, the entire economy froze.
Extremely unequal wages and income contributed to the collapse of consumer buying power. If consumption had been based on a foundation of healthy wage growth, the situation would have been considerably less volatile.
Ingredient Two: Financial Speculation
The dynamic of debt-based consumption was bad enough. But there was another way that inequality contributed to crashing the economy. At the top of the economic pyramid, those in the top 1 percent were doing their part by taking part in risky gambling. Unfortunately, the gambling was not confined to a casino, where the losses could be contained, but took place at the heart of our whole economy.
In 2007, the richest 1 percent owned 36.5 percent of all the private wealth in the United States and over 42.4 percent of all financial assets. Part of this estimated $20 trillion in wealth was in the form of land, houses, artwork, jewelry, private jets, and other private property. But an enormous fraction of it was in the form of stocks, bonds, and ownership stakes in the world’s corporations.
The 99 percent, when they have money to invest, look to banks, bonds, and mutual funds. But almost everyone in the 1 percent has investment professionals who advise them about allocating their invested wealth. So imagine for a moment that you’re a member of the 1 percent, with $200 million in wealth, and I’m your trusted investment advisor. It’s sometime between 2000 and 2007.
I explain that a typical asset allocation strategy is to park a portion of your wealth in stable investments that are a bulwark against serious market downturns. These include insured deposits in banks and credit unions and bonds backed by local, state, or federal governments. This guarantees that you will always be rich, even in tough times. The problem, I explain, is that these have relatively low rates of return. In fact, in 2005, we’re talking 2–3 percent returns. In other words, real snoozers.
I suggest taking another portion of your $200 million and investing in some long-term growth equities—companies that have been around for a long time. These include Ford, General Motors, and General Electric, the “blue chip” or seemingly stable companies. But it’s the same problem again: very boring and modest returns on investment, maybe 5–6 percent.
With another portion of your funds, we’ll start to increase risk and return, looking for a diversified mixture of small- and large-capitalization new companies outside the stock market. These are more interesting and have the potential for higher returns, in the 7–10 percent range.
Now we pause and take a deep breath. Our hearts start to beat a little faster in anticipation of what comes next. Up until now, we’ve pursued the investment strategy that the super-rich have employed for decades—diversified, sensible, a nice blend of risk and return. We will tweak it based on your age and special needs, but it’s a tried-and-true approach.
There is, however, a new class of investments that are generating very high returns. You’re smiling because this is what brought you in my door. These new investment vehicles are complicated but highly lucrative—dazzling returns of 10 or 15 percent. Some funds have even had 20 percent returns for five years in a row.
To get those returns, however, we have to make speculative, high-risk investments. These include investments in hedge funds, derivatives, and credit default swaps—some of the financial innovations that some very smart young fellows on Wall Street have designed. These are not investments in the “real economy,” in which firms make actual things or provide services that people use. Rather, these are ways to place financial bets on the movement of money and markets. The question for you is, how much are you willing to risk?
Think about your $200 million. If all you had was $20 million, you would be able to live a very wonderful life, meet all your material needs, and guard against most possible problems. You might not be able to buy genuine love or eternal life, though you’ll probably live longer. You’ll be able to go to the Mayo Clinic for whatever medical need you have and enjoy every luxury the planet has to offer. With another $20 million, you will be able to provide the same to your progeny.
So, setting aside that $40 million, you have $160 million you’re willing to gamble with. Wouldn’t it be fun to keep score and watch it multiply? It is, after all, mostly just numbers on a page or screen. So we allocate a large portion—let’s say $80 million—to the new financial instruments.
Now imagine this same conversation playing out in the wood-paneled offices of the 1 percent all across the planet between 1998 and 2007. As a result, huge amounts of wealth shifted into the speculative market.
The speculative funds of the top 1 percent are merged with additional trillions of dollars in sovereign wealth funds—the colossal piles of wealth generated by Middle Eastern oil profits and Chinese exports and held by central governments. Add to this the trillions in cash accumulated by the world’s corporate 1 percent—banks, insurance companies such as AIG, and the finance arms of corporations such as General Electric. That totals trillions of dollars of wealth looking for a home—not in sleepy investments in the real economy, which are incapable of generating such large returns, but in the casino-like speculative economy.
Wall Street drove this process by seeking more and more high-risk deals. One of their favorites was high-interest mortgage debt, known as subprime mortgages. Investment banks and brokers such as Morgan Stanley, Citigroup, and Bank of America called up mortgage lenders and people who bundled mortgages together and said, “Bring us more of those high-return, high-risk deals!” So trillions of dollars flowed into the shadow financial sector—and the deals became more and more delinked from the fundamentals of the real economy.
By 2007, the speculative bubbles had grown, not just in the housing market but also in other sectors of the economy. Commodity futures rose, pushing up the cost of foodstuffs and triggering food riots across the world. Speculation in oil futures drove up the cost of oil, and a gallon of gas during the summer of 2008 topped $4 a gallon. Americans spent hundreds of billions of dollars more on gas in 2008 than they did the previous year.4 Funds that could have financed a transition to a green economy went to the oil industry, which enjoyed unprecedented profits—in 2008, ExxonMobil set records with profits of $45.2 billion.
Tick, tick, tick. Kaboom!
The extreme inequalities of wealth—stagnant wages and speculative activity—brought the economy to its knees. And here’s the bad news: it hasn’t stopped. As long as the 1 percent has excess money to bet with, they will continue seeking speculative investments.
Too bad it’s not a game in a casino. Unfortunately, it’s a very costly game. And the people paying the price with ruined lives are not in the 1 percent.
Published with permission from Berrett Koehler, copyright 2012. From the new book 99 to 1: How Wealth Inequality Is Wrecking the World and What We Can Do About It.