The Bailout Blues
by George Saravelos on October 3, 2008 in Opinion
Walking around Cambridge, it is less than obvious that this country is going through a major economic crisis. Still, over the last six months, unemployment has risen in America at its fastest pace in 25 years and consumption is growing at its slowest in almost 17.
What’s missing from the picture here? Put simply, Cambridge is too wealthy. It is the poor, not the rich, who bear the biggest burden in an economic downturn.
Since the start of this year, companies have laid off more than 700,000 workers. But the pattern of job losses has been staggeringly uneven, and the poor have been hit the hardest.
The manufacturing and construction sectors have lost more than 600,000 people. These industries are the most exposed to the economic cycle. They also employ mostly low-income workers with only basic education. On the other hand, employment in the service sector, where salaries are higher, has been much more stable. And while a fired investment banker can now go and study for an MBA using last year’s bonus, a factory worker may no longer be able to afford health insurance.
Unemployment isn’t the only way the poor are being hit. Low-income households are more exposed to movements in interest rates because they borrow more as a proportion of total income. Monetary policy may impact household wealth across the spectrum, but it forces the poorest to change their day-to-day spending patterns. When former Fed chairman Alan Greenspan started raising rates a few years ago, the biggest impact was felt on subprime borrowers; now, low interest rates are meant to help the poor get by.
Poor households also suffer the most from volatility in commodity prices. Low-income households spend a greater proportion of their income on basic goods than the rich, and it’s these basics (like gas, bread, and milk) whose prices fluctuate most over the course of the economic cycle. Four dollars a gallon may be an inconvenience for some - cause for purchasing a smaller SUV, perhaps - but it may force others off the road entirely.
Unsurprisingly, the key feature of the current financial crisis is that its burden will likely be heaviest on the have-nots.
Financial institutions, spurred by investment banks, went on a spending binge of unfathomable proportions over the last ten years. The underlying mechanism of profit generation was leverage: put up a small amount of capital as collateral, borrow money and invest in something riskier. If prices go up, your returns as a percent of your initial capital are unlimited. If prices go down, losses are limited to the capital invested.
It turns out the prices of these investments went down this year. Some banks have gone bust. Now we are told that this country will revert to the Stone Age unless $700 billion is put up to save the financial system. The costs of a collapse (arguably) outweigh the benefits of wiping out bank capital and shareholders.
Maybe so, but the distribution of costs is again disproportionate: profits were private until a year ago (when prices rose); bank losses will now be socialized (when prices are collapsing).
To be sure, free-market economies have been overwhelmingly successful over the last two centuries. By rewarding risk-takers, they have encouraged efficiency gains and idea generation. But the economic history of capitalism has been equally well-defined by booms as well as busts - from the Great Depression of the 1930s to the U.S. Savings and Loan crisis of the 1990s, from the dot-com bust to the credit bubble of today.
Amidst our focus on the risk-takers, we forget that the risk-receivers who bear the costs when risks go wrong are disproportionally poor. These are the people who have enjoyed the boom the least, but pay the most when it goes bust. They sit at the bottom of the economic food chain during upturns, and they are still at the bottom during downturns. They act as the shock absorbers of the system.
Maybe the promise of joining the ranks of risk-takers is sufficient to compensate for the cost. Some call it equality of opportunity. Whatever the costs of being a risk-receiver are, however, last week they got a hell of a lot bigger.
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2 Responses to “The Bailout Blues”
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The financiers are snookering us again. We, the taxpayers, will never see that money once Congress caves in to special interests, (as usual). If we try to get it back by taxing these businesses, then they will take the good parts of their portfolios and flee to other countries. Suckers!
If we use that money to enhance social security, then all of the retirees that lost their retirement funds in the stock market will at least be guaranteed a reasonably comfortable retirement. (The only ones who will still be unhappy are the ones trying to retire to their mansions.)
Finally! Congress has found the money to make social security work.
Let Congress know that if they get fooled by this bailout, then the only thing for voters to do is punish congress the way it was punished for the gulf war.
Bryant Arms
Banks and Bankers became greedy at one point. They simply wanted to have the biggest portion of the pie, while the majority of low-income people were living on the basics. Their greediness rendered the system unstable, and now the savings of all are at stake.
The points Mr. Saravelos is making are right, but the question still remains unanswered: Should low-income taxpayers pay in order to bail out the big bankers? The bankers that once used to receive thousands or even millions of dollars as bonuses. Should they get punished for their greediness or not?