By Barry Elias | Friday, 23 Oct 2015 07:24 AM
I attended a presentation this past week at Cooper Union College in Manhattan by an economist promoting his new book.
I was rather aghast to hear him say: “No one” predicted the global economic crisis and experts did not foresee how slow the recovery would be.
Following the collapse of Bear Stearns on March 17, 2008, I divested most of my family’s investment portfolio from the market when the Dow Jones Industrial Average hovered near 12,000. By September of that year, the Dow reached its nadir – around 6,500.
At that time, I expected the unemployment rate to double from 5 percent to 10 percent, which it did. I also suggested the global recovery may take a decade or two to return to robust growth, since the crisis was the result of financial mismanagement that spanned several decades.
Further, on May 6, 2010, the day of the infamous “Flash Crash,” my article entitled “Why I Divested From the Dow” was published: About six hours later, the Dow had plummeted about 1,000 points.
The Cambridge-educated economist that I alluded to earlier is Adair Turner, the chairman of the Institute for New Economic Thinking; a member of the United Kingdom’s Financial Policy Committee: and the former chairman of the Financial Services Authority (FSA) until its abolition at the end of March 2013.
The FSA was an independent regulatory body for the financial services industry in the United Kingdom (U.K.) between 2001 and 2013. It was appointed by the Treasury and funded entirely by fees charged to financial firms.
Due to the apparent regulatory failure of banks during the financial crisis, the U.K. government abolished and replaced the “failed” FSA on April 1, 2013 with two new agencies: the Financial Conduct Authority (FCA) and the Prudential Regulation Authority of the Bank of England, in an effort to strengthen England’s financial system with a more forward-looking perspective.
While the FSA under Turner’s leadership presided over the near-total collapse of several major financial institutions, including the merger of Lloyds Bank with ailing HBOS in September 2008, Turner claimed in February 2009, as well as today, that other global regulatory authorities also failed to predict the economic collapse. He did not apologize for the actions of the FSA, and believes the intellectual failure was the result of a focus on processes and procedures, in lieu of the larger economic landscape.
Economists ought to take note of that admission and view the world with greater breadth and depth, especially before proposing public policy prescriptions that may have implications for many decades to come.
In his new book, Turner argues most credit formation is not necessary for economic development. He suggests excess credit drives real estate booms and wealth inequality, which then lead to financial crises and depression. Turner believes banks need to increase capital and reduce real estate lending, and debt needs to be taxed as a form of “economic pollution.” I wholeheartedly agree with the premise and prescriptions presented.
Income inequality is self-reinforcing, since wealthier households consume a smaller percentage of their income, and savings tend to be invested in short-term, speculative, and arbitraged financial assets. This dynamic undermines employment and economic growth for the masses as compared with direct investment. Favorable tax rates on investment income, especially for hedge fund managers, perpetuates this viscous cycle.
Since 1970, financial firms expanded credit among themselves and households seeking real estate, because it involved a simple and secure business model: real estate collateral valuations were more predictable as compared with the assessment of an entrepreneurial endeavor. This methodology permitted the excessive refinancing of existing assets, and less on the creation of new ones.
Financial firm credit skyrocketed from 10 percent of GDP in 1970 to 125 percent in 2008, while that for household credit rose from 40 percent to about 90 percent, which included toxic subprime mortgages. (During the same period, federal government debt as a share of GDP increased from 35 percent to 60 percent, and that for non-financial corporate debt rose slightly, from 35 percent to 40 percent.)
The financial firms essentially transferred wealth among themselves and others instead of creating new wealth. This led to less optimal employment and income growth for the masses, since direct investment in business endeavors was on the wane. Instead, financial products that were derived from preexisting assets exploded, and wealth and income inequality grew.
The net worth of the financial sector was negative from 1996 through 2007, reaching a nadir of negative $1.46 trillion in April 2007. Quantitative easing by the Federal Reserve following the financial crisis put the financial industry in positive territory, but it turned negative at the end of 2013, and by of June of 2015 it stood at negative $809 billion.
Why was the financial industry protected so well?
Some suggest a significant number of economists with keen academic and think-credentials regularly accept funding from corporations to provide “objective” analyses that actually promote corporate objectives and defy evidence and logic.
Let’s keep the economists honest and forward-looking, shall we?
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