Financial History 25th Anniversary Special Edition (104, Fall 2012) - Page 39

While it may be true that history does not exactly repeat itself, the events occurring during the recent credit crisis would have been familiar to anyone who lived through the 1929 crash and the depression. The well-worn cliché certainly gives validity to the more accurate idea that events seem to re-occur because of the limited universe of possibilities and events that combine to produce a financial crisis. In just two short years, Wall Street had experienced more tumultuous events than at any other time since 1929. The collapse of the credit markets in 2008 and the sharp drop in the stock market indices helped Barack Obama win the presidency, as it appeared that desire for economic and social change was in the air after eight years of a Republican presidency. The events of 2008, in particular, were eerily reminiscent of 1932 in the markets. The following two years also displayed significant parallels to 1933 and 1934. The parallels were striking because it became apparent that, as in 1929, Wall Street had created the crisis through its disregard for investors and the manufacturing of securities, to use Charles Mitchell’s original phrase. Lack of due diligence by investment bankers helped create the conditions for the market crash in 1929 and would prove a decisive element in financial reform after 2009. Poor collateral pledged against mortgage securities was the culprit, again demonstrating that banking oversight was sorely lacking. The 1920s and 1930s had no effective regulator to monitor the process, and the same proved true in the contemporary period after 1999. The early 1930s and the early 2000s also shared another trait that would surface again. Bankers in the 1930s, as their counterparts in the 2000s, had no effective critics to check their activities. Wall Street figures again were in the limelight, as they had been 80 years before, treated as celebrities who reigned over an industry that had lost most of its meaningful regulation. Goldman Sachs partners replaced those from J.P. Morgan & Co. as advisers to government, while the media doted on mutual fund managers, bankers and corporate chief executives as the latest prophets of wealth and the architects of a new economy that would only rise from year to year. But the events of 2009 quickly caused an about-face that challenged Wall Street rather than praised it. Joseph Schumpeter’s notion of capitalism’s tendency toward creative destruction was not a concept that critics of Wall Street embraced as the aftermath of the credit market and mortgage crises became clear any more than social Darwinism was widely embraced in the 19th century. Ironically, however, the great historical discrepancies between wealth and income in the United States began to be mentioned again, as they had in the 1930s. During the Great Depression, Marxist criticism gained some popularity because it highlighted the inequalities in society. In the 2000s, similar criticisms were heard, and the question of whether financial capitalism could survive the economic turmoil began to be raised again. Such an idea would have been ruled absurd 10 years before, despite the dot com bubble bursting and the follies of Enron and WorldCom. The vast discrepancies in annual income, in particular, began to draw attention as the popular tide turned against Wall Street. For several years, critics had inveighed against tax breaks given to hedge fund managers and those in private equity whose annual income effectively was taxed at the long-term capital gains rate of 15%. As the institutions receiving TARP capital infusions became more widely disseminated, the idea of tax favoritism was viewed as highly repugnant at a time when home mortgage foreclosures were at historically high levels. At the same time, some hedge fund managers made substantial profits effectively shorting the market for residential mortgages while mortgage holders were in poor economic straits, recalling the bear raids of the early 1930s. This was in stark contrast to the appearance of tent cities, the contemporary version of Hoovervilles, in areas most ravaged by the foreclosure crisis. It was difficult to draw realistic or meaningful parallels between the profitability of John Paulson’s hedge fund and the aggregate value of average workers’ paychecks. Attempts of that sort had been made before in the 1930s, but the comparisons were considered too inaccurate and polemical to be of any real value. Yet it was clear that vast discrepancies existed. In the early 20th century, discussions about the discrepancies of wealth in the United States usually emphasized the wealth of a small portion of the population compared with the rest of the country. Usually, the top 5–10% of the highest paid held around 90% of the country’s assets. It sometimes was difficult to determine who fell into that top group, individuals or corporations. Gustavus Meyers raised the issue, citing interlocking directorships as evidence of highly-paid elites. The Pujo Committee extended the comparisons using corporations as its starting point before World War I, and Adolph Berle and Gardiner Means extended the analysis again in 1932. But it was the socialists who made the analysis on a personal income or household income basis. In 1936, in Rulers of America, American socialist writer Anna Rochester noted that a small fraction of American families (1/10 of one percent) at the top of the income scale received as much as 42% of families at the bottom of the scale. At the time, that meant those earning $75,000 per year or more at the top versus less than $1,500 at the bottom. In the 1920s, that sort of discrepancy was described as being offset by the percolator theory, or “trickle down” economics. A similar case was made after 2009, although not very successfully. A similar discrepancy in income was shown by the Congressional Budget Office (CBO) 75 years later. In a report comparing trends in household income between 1979 and 2007, the CBO came to a similar conclusion: “For the one percent of the population with the highest income, average real after-tax household income grew by 275% between 1979 and 2007 . . . for the 20% of the population with the lowest income, average real after-tax household income was about 18% higher in 2007 tha