What follows is a short synopsis of Dee Hon’s great article in the November 23rd issue of Adbusters.
Hedge fund masterminds, who command salaries in the tens of millions (for their supposed financial prescience) did something very stupid. They bet their investors' multi-billions on the belief that subprime borrowers, with lower incomes and/or rotten credit histories, would miraculously find a way to pay back loans that too much exceed what they earn. But these sub-prime borrowers failed to find that miraculous way, and now surging loan defaults are sending shockwaves through the markets. Yet despite the turmoil that this collapse is wreaking, it's just the first ripple to hit the shore. America's debt crisis is far worse than most people know. How did it come to this? How did America, collectively and as individuals, become a nation addicted to debt -- pushed to, and often over, the edge of bankruptcy? The savings rate in America hangs below zero. Personal bankruptcies are reaching record numbers. America's total debt averages more than $160,000 for every man, woman, and child. China holds nearly $1 trillion in US debt. Japan and other countries are also owed big. And it seems they will be paid back in currency that is worth ever less than the currency they used to buy these many treasury certificates they hold.
The story begins with labor. The decades following World War II were boom years. Economic growth was strong, and powerful industrial unions made the middle-class dream attainable for working-class citizens. Workers bought homes and cars in such volume that they gave rise to the modern suburb.
However, prosperity for wage earners reached its peak in the early 1970s. By then, corporate America had begun shredding the implicit social contract it had with its workers, pressured by the reality of tough foreign competition to do so. Companies cut costs by finding cheap labor overseas, thereby forcing down wages at home.
By 1972, wages had reached their peak. According to the US department of Labor Statistics, workers then earned $331 a week, in inflation-adjusted 1982 dollars. Since then, however, it's been a downward slide. Today, real wages are nearly 20% less – despite the fact that real GDP-per-capita doubled over the same period. What this means is that instead of reducing the length of the workweek by half (for those of us who wished to consume no more than we did in 1972), we were, on average, having to work either 20% longer or 20% harder, just to stay even, materially, with where we were at in 1972! And if we wanted to exceed the consumption levels we enjoyed in 1972, many of us needed to go heavily into debt . . by way of ever-abundant credit card offers and sub-prime mortgages.)
Even as wages fell, consumerism was encouraged to continue soaring, to unprecedented heights. Buying stuff became a patriotic duty that distinguished us from our communist Cold War enemies. In the eighties, consumers' growing fearlessness towards debt, plus their hunger for goods, were met with Ronald Reagan's deregulation of the lending industry. Credit not only became more easily attainable, it became heavily marketed. Credit card debt, now standing at nearly a trillion dollars, is more than triple what it was in 1988, after adjusting for inflation. Barbecues and TV screens are now the size of small cars. So much the better to fill the average new home, which even in 2005 was more than 50 percent larger than the average home in 1973. (Keep in mind, however, that the McMansions and the large second-homes of the rich greatly drive up today’s average home size. Forty percent of all new homes being purchased these days are second homes for the rich.)
This is all great news for the corporate sector, which both earns money from loans to consumers, and profits from their spending. Better still, lower wages means lower costs and higher profits.
Given a choice between working for diminishing returns and joining the leisurely riches of the rentier/investor, people tend to pursue the latter, to whatever extent they can. People of all professions sought to have their money work for them, and poured their savings into investments. This spurred the explosion of the finance industry, and greatly profited the people who manage money for others. The now-$10 trillion mutual fund industry is 700 times the size it was in the 1970s. Hedge funds, the money managers for the super-rich, numbered 500 companies in 1990, managing $38 billion in assets. Now there are more than 6,000 hedge fund firms handling more than $1 trillion dollars in assets.
In recent years, the further enticement of low interest rates has spawned a boom for two kinds of “rentiers” who are at the root of the current debt crisis: home buyers and private equity firms. But it should also be noted that low interest rates are themselves the product of outsourced labor. And why is that? America gets goods from China. China gets dollars from the US. In order to keep the value of their currency low so that exports stay cheap, China doesn't spend those dollars in China, but buys US assets like bonds. China now holds nearly a trillion American dollars in such IOUs. This massive borrowing of money from China (and to a lesser extent, from Japan) sent our interest rates to record lows. And this is what led to the trouble we are in today: Cheap borrowing costs encouraged millions of Americans to borrow more, buying homes and sending housing prices to record highs. Soaring house prices encouraged banks to loan freely, which sent even more buyers into the market -- many believed the hype that real estate investment offered a never-ending escalator to riches, and borrowed heavily to finance their dreams of getting ahead. They also began borrowing against the skyrocketing value of their homes, to buy furniture, appliances, and TVs. By this means these home equity loans added $200 billion to the US economy in 2004 alone.
It was all so wonderful. The boom would feed on itself. America could produce ever less stuff of any real value, internationally -- for apparently all that needed to be done was to keep buying and selling each other's houses and businesses, with money borrowed largely from the Chinese. (A slight exaggeration, but still instructive.)
On Wall Street, private equity firms played a similar game: buying companies with borrowed billions, sacking employees to cut costs, and then selling the companies to someone else who did the same. These leveraged buyouts inflated share values, producing billionaires all around. The virtues that usually produce profit (i.e. innovation, entrepreneurialism and good management) stopped mattering, so long as there were bountiful capital gains.
Problem is, the party is coming to a halt. An endless housing boom requires an endless supply of ever-greater suckers to use, all of them borrowing heavily to pay ever more for the very same homes that their parents might have purchased for much less. (The rich, as Voltaire said, require an abundant supply of the poor. And the more suckers among them, the better.) Unscrupulous mortgage lenders have mined ever deeper into the ranks of these poor shlubs, to find suckers for the loans they wanted to issue. Chief among their shady practices were teaser loans that promised low interest rates which rose nicely after the first few years. Less-than-desirable (sub-prime) borrowers, suckers all, were told the future pain would never come, since they could keep re-financing against the ever-growing value of their homes. Lenders then repackaged these shaky loans as bonds (“collateralized debt obligations”) to sell to cash-hungry investors like hedge funds. Conveniently, the Bush-appointed heads of regulatory agencies were looking the other way.
As with any pyramid/Ponzi scheme, however, the supply of suckers inevitably ran out. Housing prices leveled off, beginning what promises to be a long, downward slide. And just as the housing boom fed upon itself, so too, will its collapse: The first wave of sub-prime borrowers have already defaulted and the resulting flood of foreclosures sent housing prices falling further. Lenders somehow got blindsided by news that, in the face of jacked-up interest rates, poor people with bad credit weren’t able to pay back fast enough on what they had borrowed. Frightened, lenders stopped the flow of easy credit, inadvertently reducing the supply of homebuyers still further. Hedge funds that merrily bought sub-prime loans collapsed.