Tuesday, November 11, 2008

Sub-Prime Poverty

Bank failure and the sub-prime mortgage fiasco have provoked so much debate, analysis, hand-wringing and finger-pointing as to leave the impression that everything that can be said about them already has been said. We all know by now that the banks loaned too much money to folk who could neither muster an adequate deposit on the house they wished to buy, nor keep up with their payment obligations.

Nobody, however, seems to have wondered why - after a decade of prosperity and economic growth - so many people were unable to get a conventional toehold on the property ladder. Why the need for sub-prime mortgages in the first place?

Part of the answer lies in house price inflation. But why did house prices rise by so much when other prices didn't? To answer this, we need to understand that when banks make a loan - not just a mortgage loan but any loan - a large of proportion of the funds will consist of money that didn't exist before the loan was made. That's right. No matter the guise under which it appears, or the complexity of the financial instrument that creates it, under a fractional reserve banking system - which is what we have - new debt means new money. And when new money unlinked to output enters the economy it causes inflation. Remember those loan offers that dropped into our mail box every morning? Many of us took the bait. Result: loads of new cash scurrying in search of something to buy. We spent a great deal of it on cheap imports from the far East and elsewhere and thereby hid some of that inflationary pressure. But you can't import real estate; and that's where the underlying inflation showed itself. House prices went skyward.

The second part of our answer is more sobering. During the five years from 2000 to 2005, the US economy grew 14% and productivity grew even more - by nearly 17%. Over the same period, median family income - the level at which half the households earn more and half earn less - actually fell by 3%, while unemployment rose slightly. So where did the income from growth go? Mainly to corporate share-owners and company bosses. By 2006, Chief Executive Officer pay was over 250 times that of the average wage. In the 1960s that ratio was only 24 to 1.

Therein lies the source of the sub-prime phenomenon.

Those hundreds of thousands maybe millions who took out mortgages beyond their means are a direct reflection of increasing inequality and - yes - poverty. People were promised the American Dream and then found - too late - that carpet baggers, corporate directors, and feckless politicians in Washington and Westminster had placed it beyond their reach.

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