Home > Uncategorized > Understanding the Middle Class Angst post 2007 Crash

Understanding the Middle Class Angst post 2007 Crash

Understanding the Middle Class Angst post 2007 Crash  [A 2 year old article published in Sunday Guardian recently]

 

 

World stocks have been falling in spite of better-than-expected US jobs data. REUTERS

s the world plunges into a long-term bear market that could last another two years or more, it has become obvious that there are no easy or quick fixes to the current set of problems that grip the world economy.

The hope that the world’s central bankers could rekindle growth with Keynesian stimulus packages is fading. The debt created by the stimulus packages in the US is too large in relation to the underlying GDP of most developed countries to permit easy refinancing from bond markets. The developed world now faces grim prospects, wherein real cuts in living standards are necessary, at least for a while, before normal growth returns. The burden that this entails needs to be shared optimally and equitably if social tensions are not to explode. So far, little thought has been given to the problem of how these might be shared without impairing future growth prospects or further deepening social fissures.

The run-up to the market crash of 2008 was characterized by a banking system that had run amok in terms of credit creation, credit quality and trading little understood credit derivatives. This binge was underpinned by a lax Federal Reserve or FeD, the US Central bank, under Alan Greenspan that believed market could do no wrong and abdicated its regulatory role to the markets themselves. The credit bubble was left to collapse on its own. Therefore, when the collapse came in 2008, it was after credit had run through two decades of uninterrupted expansion. The crash in the markets, particularly bank stocks, laid bare the full extent of the havoc wrought by unrestrained lending. Hundreds of banks failed. More were threatened.

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The debt created by the stimulus packages in the US is too large in relation to the underlying GDP of most developed countries to permit easy refinancing from bond markets.

 

The authorities chose to save the banking system instead of letting the bad ones fail and the rest regroup and consolidate. Much of the so called “Keynesian stimulus” that the Central banks created has gone towards “replacing” impaired bank capital rather than asset and job creation. No wonder then that trillions of dollars poured into banks neither created new jobs nor stimulated growth. Banks have used to the money to replace capital that had been paid out earlier as dividends in good times to distribute unreal paper profits.

As the FeD drives interest rates to zero, or even negative, it impacts the wealth and well-being of people profoundly. The reality is that the poor have no savings that the FeD can tap into, and the super-rich escape its regulatory ambit by using hedge funds to park their savings, which in turn follow global returns. The only people with savings that FeD can access through its hold on the banking system is the middle class that uses domestic asset classes to park it savings. The net result of the FeD’s effort to shore up bank capital has resulted in huge wealth transfer from the middle class to banks. Barring a few lucky bondholders, most middle class savings have vanished or diminished beyond repair. The level of pain being inflicted on the middle class invites revolts against the system. That is more obvious in Europe where the banking system took a larger share of the toxic mortgage losses than in the US. What can be done to mitigate middle class pain and ensure more equitable burden sharing that also helps foster growth in the real economy? Warren Buffett has pointed to the way forward by suggesting taxes on the super-rich. It is necessary to understand the particular context of this suggestion before condemning it as a return to the evils of socialism.

The super-rich escape hidden levies imposed on savers through an artificially low interest rate regime by parking their funds in hedge funds that get global returns and pay no taxes in the US.

More than that, much of the losses incurred by the banking system in trading credit derivatives resulted in huge profits to hedge funds that went short in toxic mortgages. Nothing wrong with that. Trading is a fair, if zero sum game, and if the banks were foolish and hedge funds smart, it is no concern of anybody. But there is a caveat. Had the FeD not bailed out the banks, there is no way by which the hedge funds could have collected on the bank obligations due to them. Their profits, howsoever fairly earned, would have remained paper profits and would have had to be written off as unrecoverable.

What I am trying to say is this: but for the FeD bailout for banks in full, there would be no real profits to hedge funds and their super-rich clients. These are the profits that Warren Buffett wants to claw back, not fully but in some measure.

Can it be done? As social tensions rise because of the invidious nature of burden sharing, meaningful action becomes less likely. The route taken by UK to adjustments by reducing transfer payments to the have-nots has led to unprecedented rioting in London and elsewhere. Greece, Portugal, Spain, Italy are not finding the money required to fund their deficits and may have to cut back on subsidies.

 

he US is better off because of the dollar’s safe haven status. But it too will find social tension spiral upwards. It is society’s goodwill that gives currency to the wealth of the super rich. Charity is one way to recycle some of the profits back to the have-nots. Under normal circumstances that is the preferred way to do things. In extraordinary times like the present, the way suggested by Warren Buffet may be the only viable way to go, albeit for a limited period of two to three years.

To us Indians this form of less than fair returns on savings through artificially low interest rates is nothing new. It was standard practice from the 70s to the 90s and was one of the bad habits that the government kicked as part of reforms. Pranab Mukherjee brought it back with a vengeance on his return as Finance Minister. After two years of being relentlessly and stealthily fleeced, the middle class is out on the streets screaming for blood. It may not know why it feels let down, and may be protesting generalised corruption, but in reality it has seen its wealth and options erode considerably in UPA coalition’s second term. That angst may be the underlying discontent that Anna Hazare has tapped into.

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