The Middle Class Credit Bubble – Part 1

Blow away the dreams that tear you apart
Blow away the dreams that break your heart
Blow away the lies that leave you nothing but lost and brokenhearted
(“The Promised Land”)

Part 1 “What cased the financial crisis?”

I’m an optimistic person. I see a lot of things in life to love. And I also know that sometimes you have to face unpleasant realities. The more I read about the financial situation today, the more I see a  situation that can’t be fixed unless there’s a major change.

People blame various things for the financial crises:

• Banks
• Subprime Mortgages
• Fannie Mae and Freddie Mac
• Investment Banks
• Insurance Companies
• Derivatives
• The Shadow (private) Banking System
• The Global Conspiracy of The Rich
• The World Bank
• Sovereign Debt
• National Deficits
• Republicans
• Democrats
• Ignorance
• Greed
• Corruption

Pick your favorite one!

Maybe it’s time to look at what we can agree on. We can all agree that there was a mortgage bubble in the United States. But that mortgage bubble is also attributed to various things:

1. banks that lent without doing due diligence about the property and/or buyers
2. subprime mortgage lenders who misled homeowners about what they were getting into
3. home buyers who should have realized they didn’t have enough money to afford a home
4. ineffective and/or nonexistent government regulation of the mortgage and banking industries
5. property market imbalances due to GSEs (government subsidized entities) like Fannie Mae and Freddie Mac
6. the selling of mortgages to companies who bundled them into derivatives that were sold by the slice

Pick your favorite one! They’re all irrelevant. Because there’s a deeper question.

Why did we have a mortgage bubble in the first place?

For decades there has been a shift of wealth from the pockets of the middle class into the pockets of the rich in America.

This shift has occurred through several vehicles:

1. erosion of the “real” (as opposed to “nominal”) value of wages via inflation
2. aggressive anti-labor actions that have hobbled unions with laws and pushed unions out of workplaces,
3. shifting from defined-benefit plans (pensions) to defined-contribution retirement plans (401k, 403b and 457b plans)
4. tax structures on all levels in the United States.

Oh yes, and one more thing:  5. easy credit.

The credit card bubble

National credit cards came into widespread use in the 1970s. Before that, a few businesspeople owned gasoline credit cards. Then came department store cards, replacing the old “layaway” system where the store held your purchase until it was paid for in full. Then came Visa and Mastercard.

The lobsters in the pot didn’t notice the boiling away of their real purchasing power in terms of dollars earned. That’s because we had lots of new purchasing power in the form of credit cards. Then came home equity loans, and some of us had even more purchasing power. Can you really blame homeowners, now underwater, who wanted that home equity credit to use as their real wages shrank?

It doesn’t matter if you blame those subprime homeowners or not. The fact is that even prime loan home buyers are increasingly getting into trouble. They too do not have the earning power to pay for their homes. Because of the the five wealth-transfer vehicles that I named above, plus the current recession, the American middle class is now broke.

Economists call it “median wage stagnation.” They’re talking about “real” wages, wages that take into account the effects of inflation. The bottom ninety percent of U.S. families have had a total increase in earnings of only 10 percent since 1973. That’s a wage increase of about one quarter of one percent per year. The top one percent, however, have watched their wages triple over that same period. Just before the financial crisis the median household income dropped by $2,000 over a six year period (2002-2007).

The mortgage bubble was the tip of a bigger middle-class credit bubble. When middle-class credit became too highly leveraged, the bubble began leaking. Bank-credit froze up, while the mortgage- and mortgage-backed securities markets melted down.

Next time: what does the de-leveraging of our middle-class credit bubble mean for our future?

Copyright © 2010 Nancy K. Humphreys