X. Big Business Excesses and Erosion of Societal Norms

The May 2011 “Vanity Fair” article by the economist Joseph E. Stiglitz provides an interesting take on how the massive shift of the nation’s wealth to the upper few percent of the U.S. population has eroded societal norms. Stiglitz says, “Of all the costs imposed on our society by the top 1 percent, perhaps the greatest is this: the erosion of our sense of identity, in which fair play, equality of opportunity, and a sense of community are so important.” Stiglitz believes that the more divided a society becomes in terms of wealth, the less willing the wealthy become to spend money on consumer needs.

And what has been instrumental in driving this concentration of wealth at the top? Stiglitz identifies capital gains as a major culprit: “Lowering the rates on capital gains, which is how the rich receive a large portion of their income, has given the wealthiest Americans close to a free ride.”

A theory has been developed to support the idea of giving tax breaks to the rich, allowing for the manipulation of the financial system — Stiglitz cites it as one of the major causes of today’s inequality. The theory is called “marginal productivity theory,” which associates higher income with higher productivity and a greater contribution to society. “Trickle-down” was built on this kind of thinking.

Now that we have explored a noted economist’s views on why and how concentrating a nation’s wealth at the very point of a pyramid is bad for a society, we can take a look at some of the ways we got into “bailout mania” in late-2008.

By 2005, hedge funds accounted for nearly half of all stock trades. They played a central role in the creation of credit-default swaps (CDS) and other financial exotica. A credit-default swap is a form of insurance which protects the CDS in case of a loan default. If the loan defaults, the buyer of the CDS can exchange or “dump” the defaulted loan for the face value of the loan.

By the end of 2007, the outstanding CDS amount was $62.2 trillion, falling to $38.8 trillion by the end of 2008.

A major contributor to the financial crisis in 2007 but coming to a boil in late-2008, was what are called mortgage-backed securities. These are a bundle of securities that have been sold by banks to Fannie Mae, who then repackages them and sells them to individual investors. This process allows the banks and mortgage companies to sell mortgages off and then take them off their balance sheets.

Banks and mortgage companies made loans with no money down. Bundling of securities removed an important discipline for good lending practice.

Another major contributor to the financial crisis was the repeal of the Glass-Steagall Act. Although repealed in November 1999, it took almost a full decade for it to be revealed as a very bad action. Glass-Steagall created a firewall between investment banking, which issued securities ad commercial banks, which accepted deposits.

Experts believe that the repeal of Glass-Steagall contributed directly to the financial meltdown by allowing Wall Street investment bankiing firms to gamble with their depositor’s money held in commercial banks owned of created by the investment firms.

Goldman Sachs represents an example of how financial firms were deceiving their own clients and profiting at their expense. Goldman Sachs’ employees were making side bets against the very risky investments they were selling. In short, Sachs was selling “short” on the mortgage market’s meltdown. Brokers were recommending securities to clients that they were disparaging in emails — often in very crude language.

The next blog will continue the exploration of our “casino” economy and the corruption underlying it.

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