The roots of this economic crisis are very much centered in the growth in inequality over the past three decades. This becomes clear once we recognize that the financial turmoil is a minor aspect of the overall crisis, and that its primary cause is the economic imbalances created by the housing bubble.
The financial crisis produced great drama and headlines, as we got to watch the treasury secretary, the Federal Reserve Board chair and the CEOs of collapsing banks stay up late on weekend nights patching together bailout packages. However, this show was just a sidebar to those of us who don’t work for these banks or own large amounts of their stock. While the Fed and Treasury bailouts were sold as necessary to save the economy, they were mostly necessary to rescue Goldman Sachs, Citigroup and the other big financial institutions.
In the worst-case scenario, the major banks would have been taken over by the Fed and FDIC, leading to more uncertainty in financial markets and a tidal wave of lawsuits. This would likely have resulted in a sharper initial falloff than what we experienced, but certainly not the second Great Depression that the politicians threatened if we didn’t cough up the money to save the banks.
The first Great Depression was not just the result of mistaken policy during the initial banking crisis; it was caused by ten years of inadequate policy response. If the government had pursued sufficiently aggressive stimulus at any point in the 1930s, it could have restored the economy to full employment long before World War II forced such stimulus on the country. By the same token, failure to rescue the banks in the fall of 2008 would not have necessitated ten years of stupid policy; a second Great Depression was never in the cards.
It is also important to dismiss the claim that the downturn is being perpetuated by the unwillingness of banks to lend because of their weak capital positions. This story doesn’t fit the facts. The capital position of many cautious banks is just fine, yet they are not rushing to make loans and steal market share from wounded competitors. Similarly, large firms have no problem raising capital at very low cost right now. Yet Wal-Mart and Starbucks are not rushing to gain at the expense of the smaller businesses that can’t borrow from banks. The problem is simply that consumers are tapped out: healthy banks are not lending, and cash-rich companies are not expanding, because weak demand makes any investment very risky.
In short, the story of economic weakness being the result of a broken banking system is a complete fabrication. This is a good story if your intention is to get more money to the banks. It is not a good story if your goal is getting the economy back to full employment.
The real story is a very simple one of a burst housing bubble. At its peak in 2006, the wealth created by that bubble and the smaller bubble in nonresidential real estate was generating more than $1 trillion in annual demand. This took the form of more than $500 billion in excess construction demand, as builders rushed to complete projects that commanded bubble-inflated prices. It also led to more than $500 billion in additional consumption, as people spent based on $8 trillion worth of bubble-generated home equity.