The global financial crisis and its effect on poor people in the United States (shunted aside in times of prosperity and even more in recession)

(May 13, 2009) As everyone knows, there has been a world financial crisis leading to a world economic crisis. This editorial indicates how poor people and others in the Unites States have been affected by the financial and associated economic crisis.

Before the financial crisis

Since the Reagan Administration poor people (and ordinary working people) have been increasingly marginalized in the US political process, both because of ideology, principally the Republican/”conservative” notion of “let the market take care of things” (including reducing poverty), the active role of Republican administrations in reducing or eliminating laws favorable to working and poor people and (more importantly) supporting laws favorable to corporations and rich people, and the marginal role of poor people in the political process. Poor people are marginalized because they are now in a minority and do not have substantial amounts of money to contribute to the political process. On the slightly positive side, they are viewed by many in the majority with some, but fairly distant, concern. Thus, before we got to the current financial and economic crisis poor people were already in trouble. For example:

income distribution The income distribution has changed dramatically, especially the gap between the top 1 percent and the poorest fifth of Americans. In 1979, the incomes of the top 1 percent were 22.6 times higher than those of the bottom fifth. Top incomes continued climbing to 72.7 times higher by 2006 — more than tripling the rich-poor gap in 27 years. The average after-tax income of the top 1 percent of the population more than tripled, from $337,000 to over $1.2 million, while the average after-tax income of the poorest fifth of the population rose only from $14,900 to $16,500, an increase of $1,600 or 11 percent.1
poverty The nation’s official poverty rate in 2007 was 12.5 percent, with 37.3 million people in poverty in 2007, up from 36.5 million in 2006. 13 Although the incomes of the richest people in the US rose substantially since 1979, the percentage of those in poverty in the United States has actually risen slightly between 1979 and 2007. 14
hunger and food insecurity In 2007, 36.2 million Americans, including 12.4 million children, either did not have enough food or feared that they wouldn’t have enough at some point during the year. 4
minimum wage It took nearly 10 years from the previous increase in the minimum wage for the United States in 2007 to begin to raise the minimum wage in stages from $5.15 an hour to $7.25 an hour (although the income of the richest 1 and 20 percent was rising greatly and US government workers, for example, received yearly wage increases over the period).2 Even the higher minimum rate will not allow families to escape poverty with the resulting $15,080 of income from a 40 hour week, 52 weeks a year, still being below the poverty line—the poverty line for a family of three in 2007 being $17,170.3 . There was no major nationwide attempt to raise wages of the working poor to a satisfactory level.
The financial crisis

While things were bad for poor people while the US economy was doing well, things are now worse. Unregulated/minimally-regulated capitalism has brought about a major worldwide financial and economic crisis. This has made poor people even poorer.

It is important to note that a financial crisis typically does lead to serious economic crisis. This has happened many times in the past in the United States and elsewhere and has been the main cause of depressions. The overvaluing of prices on the upturn, and then the failure of financial institutions because of declining valuations, leverage by financial institutions, and linkage between financial institutions, can cause everyone who has money invested, deposited or backed by these institutions to lose money, plunging the economy into depression or serious recession. (See Wikipedia, the Financial Crisis of 1873 where economic and financial over-expansion was ended, in part because of the collapse of a key financial firm, Jay Cooke and Company.) We have been spared a very serious financial crisis for many years because, as the result of the great depression, sound financial system regulatory policies were introduced. These policies and oversight have been increasingly dismantled since the Reagan presidency beginning in 1980, and set the stage for the current major financial crisis.

The United States was the center of the financial crisis (although certainly banks and other financial institutions in other countries and their national institutions that were supposed to regulate them share some of the blame). In the United States, many (not all) banks, other financial institutions such as insurance companies (especially AIG), mortgage companies, and investment bankers, made some very stupid decisions which put a lot of people at risk. The tangled web of this stupidity is too complex to unravel here, but…a few key illustrative examples!

Housing Prices Housing prices rose very rapidly in the 2000s. From an index value of 100 in 2000, national housing prices, as measured by the Case-Schiller index, rose to 189 in 2006. This dramatic rise, far outstripping the usual rate of increase in housing values, is why it was called a housing bubble early on by a few including Dean Baker of the Center for Economic and Policy Research and Nouriel Roubini, an NYU professor, and by everyone later on. Beginning in 2007 and accelerating greatly in 2008, the housing bubble burst. Housing values (as measured by the index) declined in value in 2008 to 132 (the last figure available when this was written). This means that if you bought an house in the United States for $189,000 in 2006 it had declined in value, on average, to $132,000 in 2008. Thus see the housing crisis in a nutshell. This is a decline of 30 percent. If the housing buyer had just put 10 percent down, s/he had lost money on the house and would be tempted to walk away from the house. The bank, or whoever held the mortgage (a very complicated tale, since mortgages are not held as single entities but bundled and held as mortgage-backed securities.5 As banks (see immediately below) and other financial institutions use other people’s money (deposits in the case of banks) and only have in ballpark terms about 10 percent of their own capital at risk, a decline of 26 percent in housing values can easily eliminate both the homeowner’s equity and the bank/financial institution’s own capital.

Banks. Banks make profits from other people’s money. A bank owes a lot of money to its depositors. It takes this money and lends it out. A bank’s capital position–how much of its own money it has at risk–is about 10 percent of the money it has loaned out. (The ratio of owned money to owed money is called leverage.) Thus if the assets that a bank has declines by more than the percentage it has as capital, its capital will be eliminated, and it is at risk of being taken over by the Federal Deposit Insurance Corporation. Not only banks but other financial entities such as investment banks and hedge funds were also highly leveraged, with a similar unfortunate result when values of assets that they held began to decline sharply. To get an idea of how this has unfolded in the past, and is unfolding now, see Wikipedia, Bank Run, Financial Crisis, and Global Financial Crisis of 2008.

Credit default swaps and AIG. Credit default swaps are a very arcane financial instrument, something like insurance.6 If I buy insurance it says I pay a price to insure something like my house, and if something happens, according to the legal document of the insurance, I get reimbursed. The difference between credit default swaps and insurance is that you do not need to own the underlying asset in order to obtain a credit default swap. So you–or say a hedge fund–can just bet on the price of the asset–such as a mortgage-backed security–going down. AIG was actually stupid enough to write credit default swaps in a big way, and when the housing market went down substantially, it was immediately on the hook for hundreds of billions of dollars that it did not have. The US bailed out AIG, because if it did not, many banks and other financial institutions would have failed, as these financial institutions had ‘guaranteed’ themselves against loss by writing a credit default swap with AIG! The thinking in the US government was that a default by AIG on its myriad obligations would have provoked a major financial crisis and depression. The price tag was high–the US government has thus far ‘lent’ AIG $182 billion.7

We can thus see in a nutshell how the financial crisis came about. The current crisis proceeded similarly to others, first with its overvaluation of real estate and other assets, such as commodities and the stock market, and then, as the downturn began, the possibility of quite a number of key financial institutions failing from declines in these prices, when combined with financial firm leverage. The decline in real estate values wiped out or drastically reduced the equity of large numbers of new homeowners (and real estate companies), and then as the decline continued (and is continuing) wiped out or reduced drastically the equity of banks and other institutions that owed the mortgages and securities. Though institutions thought they were protected because they had obtained insurance on their liabilities, this was not so. AIG, to name the most egregious example that had written insurance on such declines, was not able to meet the volume of claims. and thus insurance could not play a large role in offsetting losses on mortgage-backed securities, Thus, banks and other financial institutions faced large losses with a key minority becoming nearly or actually insolvent. The US government including the Federal Reserve and the Treasury, which up to this point had followed a hands-off ‘capitalism knows best’ approach to financial and other markets, suddenly launched rescue efforts worth thousands of billions of dollars in an attempt to minimize the financial, and accompanying real economic, meltdown. This would have occurred, since financial firm failure would have created losses for all those who held financial assets such as short-term borrowing, lines of credit, bonds or stocks from those institutions, possibly in turn bringing down these institutions and individuals in a cascading chain. (Before the banking reforms of the 1930s, people who had money deposited in banks that failed, lost all or a significant fraction of their money. Though the reforms of the 1930s, such as the Federal Deposit Insurance Company, did reduce depositors’ risk, the current financial crisis, if left to the FDIC alone to resolve, would have easily and rapidly overwhelmed the financial reserves of the FDIC.)

Impact of the financial crisis

A financial crisis typically leads to a depression or severe recession. Though we have not had a financial crisis for a while, that is what happens. It is useful to focus on Keynesian economics, developed as an attempt to explain the Great Depression, and how the United States and other countries might get out of it, which focuses on and explains the links between production/output and spending. (See Wikipedia “Keynesian Economics” http://en.wikipedia.org/wiki/Keynsian .) A Keynesian insight was how production was related to demand. Demand for goods in 2008/09 shrunk for several reasons including

a major decline in the value of housing and of stocks, the two biggest wealth classes for people in the United States
broadly based fear for the economy resulting in large part from the above
a reduction in business investment, which can be deferred if output is declining
Major impacts of the financial crisis and the resulting contraction in demand include the following.

Unemployment The unemployment rate (8.5 percent in March 2009 and rising) is the highest since the Federal Reserve under Paul Volker created a credit crunch to reduce stagflation in the early 1980s.8 With a more normal employment rate at something like 4.5 percent, 8.5 percent unemployment means that an additional 4 percent of the US workforce (and families) do not have a regular income and thus are much poorer.

Decline in housing values and, for many, losing one’s house The decline in housing prices has meant that many people have lost all their equity in their house. They thus must consider if it is prudent for them to give up their ownership. Moreover, much housing ownership was financed through low percentage down payments (of the houses’ value), and low initial interest rates (adjustable rate mortgages) which have subsequently risen. So this has caused additional hardship.

Increase in poverty In 2007, before the financial crisis/recession, one in eight Americans were poor, a very high level for a rich society. The recession will push an additional 7.5 to 10 million people into poverty, the Center on Budget and Policy Priorities has estimated.15

Increase in hunger As mentioned above, in 2007, 36.2 million Americans, including 12.4 million children, either did not have enough food or feared that they wouldn’t have enough at some point during the year. This number of food insecure people has certainly increased dramatically during 2008 and this year due to spikes in food prices and the recession. While the official statistics lag behind by 1-2 years, there is significant supporting evidence for a dramatic rise in hunger including the very large rise in unemployment, and the rise in TANF (Temporary Assistance to Needy Families) applicants and SNAP (Supplemental Nutrition Assistance Program) applicants.

Setting aside or minimizing effective action to help poor people Perhaps ultimately the major impact of all will be is that once again what happens to ordinary people is once again far down the list on the political agenda of the United States. During the Bush years, poor people were ignored. The magic of the market, the genius of American capitalism, were extolled in order to ‘unleash capitalism’ to produce benefits for everyone. This proved to be to be, if perhaps technically not a lie, certainly a giant falsehood involving self-deception (that permitted giant profits and income for the corporate elite) and the deception of others on a grand scale. Now what is happening that a pro-poor Administration is expending vast sums of attention, money and political capital to bail out capitalist institutions. Trillions of dollars are being spent on this. AIG–one firm, extremely stupid or greedy–for example has received $182.5 billion.9 $182.5 billion dollars, given to the 36.2 million food insecure people, would be $5041, or at an extra $30 a week for groceries, would move most of these people from being food insecure for three years. We are highly unlikely to see a check for $5041 mailed to the food insecure to make them food secure!

The Republicans in Congress profess to be ‘enraged’ by the current large budget deficits, indicating that efforts to help lower income people such as improved health insurance, sick leave, and unemployment benefits will face a difficult path in Congress.10

Adding up the government’s total bailout tab as of February 2, the government made commitments of $12.2 trillion and spent $2.5 trillion.11 In addition to bailout funds, there was a first fiscal stimulus package of $787 billion, with more to come.12 It is impossible to say what the final fiscal impact/cost will be for all of this for various reasons, but take as a low ballpark figure $3 trillion. There are approximately 40 million poor people in the United States according to Census Bureau estimates. As defined by the Office of Management and Budget and updated for inflation using the Consumer Price Index, for a family of three, $16,530. A $3,000 increase in income per person would move most people out of poverty. $3000 times 40,000,000 people equals $120 billion. So (a low estimate of) the bailout/stimulus package funds would fund 25 years of moving poor people out of poverty.13

The United States has first been enthralled by capitalism, and then ensnared by capitalism, leaving few resources for those who would most benefit from increased help.

This stinks.

Endnotes

1. Arloc Sherman. “Income Gaps Hit Record Levels In 2006, New Data Show.” Center on Budget and Policy Priorities. April 17, 2009 http://www.cbpp.org/cms/index.cfm?fa=view&id=2789 )

2. Lori Montgomery, “Congress Approves Minimum Wage Hike,” Washington Post, May 25, 2007.

3. United States Department of Health and Human Services, “Prior HHS Poverty Guidelines and Federal Register References,” http://aspe.hhs.gov/poverty/figures-fed-reg.shtml Accessed February 25, 2008.

4. Mark Nord, Margaret Andrews and Steven Carlson. “Household Food Security in the United States, 2007.” Economic Research Report No. (ERR-66) 65 pp, November 2008. USDA. http://www.ers.usda.gov/Publications/ERR66/

5 See Wikipedia, “Mortgage-backed securities. http://en.wikipedia.org/wiki/Mortgage_backed_securities The Case-Schiller index can be accessed from http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_csmahp/0,0,0,0,0,0,0,0,0,1,3,0,0,0,0,0.html or if this doesn’t work do a Google search on Case-Schiller index.

6. See Wikipedia, Credit Default Swaps.

7. See Reuters “How AIG fell apart.” September 18, 2008. http://www.reuters.com/article/newsOne/idUSMAR85972720080918 .

8. See US Department of Labor, Department of Labor Statistics, “United States Unemployment Rate” http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=LNS14000000

9. Hugh Son and Zachary R. Mider. “AIG results are said to exclude more bailout cash.” Bloomberg News May 4, 2009 http://www.bloomberg.com/apps/news?pid=20601103&sid=anLdzOeVM_tc&refer=news .

10. Lori Montgomery. “Congress Approves Obama’s $3.4 Trillion Spending Blueprint” Washington Post April 30, 2009 http://www.washingtonpost.com/wp-dyn/content/article/2009/04/29/AR2009042901033.html.

11. New York Times “Adding Up the Government’s Total Bailout Tab” February 4, 2009. http://www.nytimes.com/interactive/2009/02/04/business/20090205-bailout-totals-graphic.html

12. fxstreet.com. “Fiscal Stimulus Package in a Nutshell” February 15, 2009 http://www.fxstreet.com/fundamental/analysis-reports/daily-global-commentary/2009-02-15.html .

13. US Bureau of the Census, “Household Income Rises, Poverty Rate Unchanged,
Number of Uninsured Down” August 26, 2008 http://www.census.gov/Press-Release/www/releases/archives/income_wealth/012528.html

14. See US Bureau of the Census, “Income, Poverty, and Health Insurance Coverage in the United States: 2007” p.12 table. http://www.census.gov/prod/2008pubs/p60-235.pdf .

15. Eric Eckholm. Rising unemployment could push an additional 7.5 million to 10.3 million United States residents below the federal poverty line in the next two or three years, study says New York Times November 24, 2008