Inequality as a critical cause of the financial crisis?

by Linda Beale
crossposted with Ataxingmatter

Inequality as a critical cause of the financial crisis?

As readers know, Ataxingmatter is premised on a concept that I have called “democratic egalitarianism.” that This is the idea that sustainable democracy requires forces that push economic and other resources towards a more equal distribution rather than permitting resources to accrue more and more to the already powerful and well-resourced amongst us. Redistribution, that is, occurs all the time in every economy. Much of redistribution is redistribution upwards–power accrues power; wealth accrues wealth; and accordingly opportunity accrues opportunity. Taxation is one of the mechanisms that society can use to counter the natural tendency towards redistribution upwards. In a democracy, that mechanism is necessarily and appropriately limited, but it can be servicable on a small scale. Thus, mechanisms such as income rather than consumption taxation, progressive tax rates, taxation of large estates passed to beneficiaires, exemptions and refundable credits sufficient to ensure a sustainable livelihood for those who have (and earn) least, and similar provisions can serve to switch the default direction of redistribution from ‘redistribution to the have-mores’ to ‘redistribution to the have-nots’ at least to some degree.

So how does that view of democracy and the need for “democratic egalitarianism” impact upon one’s understanding of the causes and appropriate cures for the financial crisis that expanded into a deep recession bordering on depression?

In my own analysis of the financial crisis (to be published by the IMF, and currently available through SSRN here), I focused primarily on the deregulation/privatization/and tax cutting at the core of the reaganomics trickle-down ideology and the way that led to a predatory casino banking mentality that in turn was fed by the ease of speculation made possible by financial product innovations like naked credit default swaps. Similarly, the risk inherent in this type of banking was increased as institutions consolidated, increasing in resources and in interconnections with other financial institutions (including through the use of new-fangled derivatives).

I didn’t focus, though, on a singular fact about our society that relates to our deepest economic woes during the Great Depression as well as our current Great Recession–the rapid growth of inequality, and the attitudinal changes that likely accompany that (e.g., rampant expansion of greed as a primary motivating factor for human behavior, acceptance of incredible differences in access to resources and influence over governmental decisions without an acknowledgement of corresponding obligations, predatory behavior by lenders and other businesses). But surely it is noteworthy that of all the remedies that could have been taken to address the economic crisis that developed out of the financial institution crisis, the only one that would have kept more people in their homes and protected entire neighborhoods and cities from the blight of foreclosed properties–permitting bankruptcy adjustments of home mortgage loan principal amounts–was never a real option. Banks ended up being more important than millions of homeowners (and the communities that were impacted by their homelessness and joblessness).

Raymond H. Brescia, at Albany Law School, has filled that gap, with an article titled The Cost of Inequality: Social Distance, Predatory Conduct, and the Financial Crisis (draft Aug. 17, 2010) (available on SSRN). He starts with a pair of quotes that are noteworthy in themselves.

An imbalance between rich and poor is the oldest and most fatal ailments [sic] of all republics. Plutarch

The injunction of Jesus to love others as ourselves is a recognition of self-interest . . . We have to tolerate the inequality as a way to achieving greater prosperity and opportunity for all. Lord Brian Griffiths, Vice Chairman, Goldman Sachs International

In the abstract, Brescia explains that the “stunning increase in income inequality…was reminiscent of … the years leading up to the Great Depression.” In the paper, this is illustrated with the following graph: Table Three: Share of Total Income Going to Top 10%, id. at 14.

Brescia notes “several possible explanations for the potential connection between rising income inequality and the great strains on the economy it causes. Did rising income for certain sectors lead to an ability to use that income to influence po,icymaking in such a way that favored those sectors? Did such income inequality pressure politicians to promote policies that favored easy access to credit as a way to mollify lower income constituents who might otherwise grow frustrated with their own stagnating wages in the face of such inequality?” He offers a third explanation–“that both income inequality and racial inequality created greater social distance and this social distance, in turn, led to greater predatory conduct… that turned a mortgage market into an economic killing field.” The abstract further notes critical insights from looking at the crisis from the perspective of inequality data.

1) the greater the income inequality in a state, on average, the greater the delinquency rate in that state.
2) the greater the generalized trust in a state, the lower that state’s delinquency rate
3) the higher the social capital in a state, and the higher the level of volunteerism in a state, the lower its delinquency rate
4) the higher the median income in a state, the higher the delinquencyrate in that state
5) an index of indicators–income inequality within a state, the size of the African-American population in a state and the median income of the African-American population in that state–reveals a strong correlation between these indicators and delinquency rates…[suggesting that] middle-class Afircan-Americans were targeted for, and steered towards, loans on unfair terms, precipitating the foreclosures that are now concentrated disproportionately in communities of color.