sss 2011 conference

The Debt Crisis and Rising Inequality

John Bradford

I. Inequality of Wealth and IncomeII. Debt and FinanceIII. Power and Monetary PowerIV. Who owns the US Debt? (Ourselves)

Wealth Concentration in the United States

Top 1 percent Next 19 percent Bottom 80 percent

1983 33.8% 47.5% 18.7%

1989 37.4% 46.2% 16.5%

1992 37.2% 46.6% 16.2%

1995 38.5% 45.4% 16.1%

1998 38.1% 45.3% 16.6%

2001 33.4% 51.0% 15.6%

2004 34.3% 50.3% 15.3%

2007 34.6% 50.5% 15.0%

Distribution of net worth and financial wealth

Source: Domhoff 2011

Financial Wealth in the United StatesTop 1 percent Next 19 percent Bottom 80 percent

1983 42.9% 48.4% 8.7%

1989 46.9% 46.5% 6.6%

1992 45.6% 46.7% 7.7%

1995 47.2% 45.9% 7.0%

1998 47.3% 43.6% 9.1%

2001 39.7% 51.5% 8.7%

2004 42.2% 50.3% 7.5%

2007 42.7% 50.3% 7.0%

Source: Domhoff 2011

Financial Wealth Distribution 2007

Source: Domhoff 2011

Income earned by the top 1% (1970-2010)

30.0

32.9

35.7

38.6

41.4

44.3

47.1

50.0

1970 1980 1990 2000 2010

Percentage of Total Income Earned by the Top 10 PercentUnited States (1970-2009)

Year

Pe

rce

nta

ge

Source: Picketty and Saez

Income earned by the top 1% (1913-2006)

CEO and Worker PayCEOs' pay as a multiple of the average worker's pay, 1960-2007

Source: Domhoff 2011

Income Inequality in Select Countries

Gini Coefficient

1. Sweden 23.0

2. Norway 25.0

8. Austria 26.0

10. Germany 27.0

17. Denmark 29.0

25. Australia 30.5

34. Italy 32.0

35. Canada 32.1

37. France 32.7

43. United Kingdom

81. China 34.0

82. Russia 41.5

90. Iran 42.3

*93. United States 44.5

Unemployment

2

5

7

10

12

1990 1997 2003 2010

US Unemployment Rate1990-2010

Year

Pe

rce

nta

ge

The inordinate Rise in DEBT

Taken from Monthly Review 2008: Sources: Flow of Funds Accounts of the United States,

Financial Debt and Profits

10

15

20

25

30

35

40

45

50

55

1976 1984 1992 2000 2008

Financial Debt and Financial Profit as a % of Total Debt and Total Profits1976-2008

Year

Pe

rce

nta

ge

Variables

Debt %Profits %

Financial Debt and Profits

US Total Debt to GDP

1.8

2.0

2.1

2.3

2.4

1996 2000 2003 2007 2010

Total Debt to GDP RatioUnited States (1976-2008)

Year

Ra

tio

Household Debt to GDP

0.4

0.5

0.6

0.8

0.9

1.0

1976 1984 1992 2000 2008

Ratio of Household Debt to GDPUnited States (1976-2008)

Year

Ra

tio

Financial Debt to GDP

0.0

0.1

0.3

0.4

0.5

0.7

0.8

0.9

1.1

1.2

1976 1984 1992 2000 2008

Ratio of Financial Debt to Total GDPUnited States (1976-2008)

Year

Fin

an

cia

l D

eb

t/G

DP

Financial Borrowing

0

20

40

60

80

100

1976 1984 1992 2000 2008

Financial Borrowing as a Percentage of Total BorrowingUnited States (1976-2008)

Year

Pe

rce

nta

ge

France

55.0

66.7

78.3

90.0

1998.0 2002.0 2006.0 2010.0

19992000 2001

2002

2003

20042005

2006 2007

2008

2009

2010

Public debt (% of GDP)

Year

Fra

nce

Germany

55.0

65.0

75.0

85.0

1998.0 2002.0 2006.0 2010.0

19992000

20012002

2003

2004

2005 2006

2007 2008

2009

2010

Public debt (% of GDP)

Year

Ge

rma

ny

Greece

90.0

94.7

99.3

104.0

1998.0 2002.0 2006.0 2010.0

1999

2000

2001

2002

2003 2004 2005

2006

2007

2008

2009

2010

Public debt (% of GDP)

Year

Gre

ece

Iceland

20.0

53.3

86.7

120.0

1998.0 2002.0 2006.0 2010.0

19992000

20012002 2003

2004

20052006

2007

2008

20092010

Public debt (% of GDP)

Year

Ice

lan

d

Ireland

20.0

35.0

50.0

65.0

1998.0 2002.0 2006.0 2010.0

1999

2000

2001

20022003

20042005

2006 2007

2008

2009

2010

Public debt (% of GDP)

Year

Ire

lan

d

Portugal

50.0

63.3

76.7

90.0

1998.0 2002.0 2006.0 2010.0

1999 2000

2001

20022003

2004

20052006

2007

2008

2009

2010

Public debt (% of GDP)

Year

Po

rtu

ga

l

Explaining Debt

• Remember: borrowing implies a lender. Financial profits rose faster than average, as did financial debts.

• Principle: To grow, banks must make more loans. Banks lend more money in order to make more money. To make more money, they ended up borrowing more money to lend, or lending borrowed money.

• LEVERAGE = DEBT: Leverage measures the degree to which assets are funded by borrowed money.

Leverage and Bank Growth

Banks can make more money in three ways:1. Borrow at lower interest rates;2. Charge higher interest rates;– Banks have little control over the first two.

Competition between banks for funding enforces some uniformity of interest rates.

3. Make more Loans! (aka increase its “Leverage”)

Increasing LeverageA Bank’s Balance Sheet

Assets = (loans)

1. Equity = cash (The Bank’s own

earnings)(aka “capital” or

“liquidity”)2. Debt =

Liabilities(Deposits and

other Debt)

Recall that Banks have reserve requirements:

1. In reality, all of this reserve does not have to be in the form of cash: it can also be in the form of any asset with a price (i.e. any commodity that can be traded)

Increasing LeverageA Bank’s Balance Sheet

Assets = (loans)

1. Equity = cash (The Bank’s own

earnings)(aka “capital” or

“liquidity”)2. Debt =

Liabilities(Deposits and

other Debt)

2. Nor does this reserve have to be owned by the bank! It can be borrowed (i.e. part of the reserve requirement can come from debt, as opposed to equity)

Increasing Leverage: ExampleStep 1: A Bank’s Balance SheetAssets $10 cash reserves$90 loans

Equity $10Debt $90

(demand deposits)

Leverage is calculated by the debt-to-equity ratio: L = D/E.

Step 1: L = 90/10 = 9Step 2: L = 100/10 = 10.• Increasing “leverage”

means borrowing more money.Step 2: Maximizing “Leverage”

Assets$100→$110

Equity $10Debt $90→$100

Shadow Banking

• The Basic Idea Behind ‘Shadow Banking’(aka securitized banking) is that IOUs (e.g. ‘securities’) are traded as money, and banks borrow against IOUs, i.e. use IOUs as collateral.

IOU Currency

Securitized Banking (selling and lending loans)

• Debt is sold to larger banks.

• These Banks then can either sell these loans again, or they can borrow against them in ‘repurchase agreements’

Securitized Banking

• Think of “securities” as IOUs that are in turn traded and passed along, as in a game of ‘hot potato.’

Loan sales increased, but most were retained

0.00

0.05

0.10

0.15

0.20

0.25

0.30

1990 1995 2000 2005 2010

Ratio of Loan Sales to Loans HeldUnited States (1991-2008)

Year

Ra

tio

*Ratio of Secondary Market Loan Sales to Commercial and Industrial Loans Outstanding

Repurchase and Sale Agreements

Bank Runs Revisited

• IOUs circulated around as money. Banks that purchased these IOUs (e.g. MBSs) borrowed against them in short-term contracts, using them as collateral to borrow cash.

• Like a mortgage, this is ‘securitized’ lending, because putting up collateral makes it less risky or more secure (contra the ‘Commercial Paper’ market).

Bank Runs Revisited

• When the value of these securities dropped, because people stopped making their mortgage payments, this (loan to value ratio) was not met.

• Lenders demanded that they be paid back, or else be given more collateral, i.e. more securities.

• This is basically a mass withdrawal on the debtors who had to find more securities or sell them to raise more money. The sale in turn caused the prices of these securities to decline even further!

• The financial panic of 2007-8 was essentially a ‘bank run’ in this secondary ‘repo markets’

Inequality and Debt: a Link?

• All money (i.e. Federal Reserve notes) is loaned into existence.

• Monetary expansion correlates with rising Debt.

• Because the power to create money is concentrated in a few institutions, inequality will rise if the aggregate interest is not re-circulated in such a way that it can be earned by workers in the form of wages.

Where does money come from?

Two Steps:1. The ‘Fed’ creates new money

as debt, from “thin air.”2. Other private banks then take

this new money and create 10x this amount through fractional reserve banking. This process is called the money multiplier process.

The Federal Reserve lending to the US Treasury

US Treasury The Fed

IOUs (Bonds)

Federal Reserve prints money, from nothing, and pays Treasury.

Money as Debt

Treasury Federal Reserve and other

Private Banks

US Treasury ‘sells’ bonds. (T-Bills)In exchange for money now, Treasury gives IOU’s, to pay back this money, plus interest.

IOU

Cash

Whatever bonds the other banks do not purchase, the Federal Reserve purchases.The Federal Reserve can exercise a power that the Treasury cannot: it can simply print the money from nothing! But it creates this money as debt.

Federal Reserve lending to the US Treasury

• Why doesn’t the Treasury just print the money?

• "The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent.”

John K. Galbraith(1908 – 2006)

Money as Debt

• All new money is loaned into existence as debt. • Because of the application of interest, total debt will

always exceed the size of the existing money supply. • Total debt, can therefore only be repaid in full by issuing

more debt to cover the interest payments.

P+INEW

MONEY CREATED

= P <

Implications: Growth or Die

1. The current system functions like a pyramid scheme: growth is a requirement for it to function.

2. The trickle-down effect of the pyramid monetary system has not been sufficient to avoid exacerbating income inequality: interest payments have not recycled back into the general population as earned income.

Power and Capitalism

Capitalism = stratified society in which accumulation of wealth fulfills 2 functions (Heilbroner):

1. Realization of prestige – (unconscious sexual and emotional needs;

Veblen)

2. Expression of power – (e.g. what Marx means by ‘self-expanding

value’; Nitzan and Bichler ‘Capital as Power’)

Power and Money

• Power = has to do with the ability to realize wishes, or reach goals …even in the face of opposition (Russell, 1938; Wrong, 1995).

• Money measures and distributes the power of payment, and payments distribute the power of ownership, including the ownership of money.

Money

Payment

Ownership=

exclusion

The “Global Pool of Money”

This implies that the housing bubble was a result of China, and other countries, saving too much money, which they lend to US banks and financial institutions.

Foreign holdings of” agency” MBSs (those issued by Fannie Mae, Freddie Mac) = $250 billion (10%) by 2000; $1.5 trillion (23%) by 2008 2007, net US international debt

= $2.5 trillion = combined GDP of Latin America and Africa

½ of this debt is held by developing countries Source: http://www.treas.gov/tic/mfh.txt

China, Main-land26%

Japan20%

United Kingdom6%

Oil Exporters 5%

Brazil4%

Carib Bnkng Ctrs 4%

Taiwan4%

Russia3%

Hong Kong3%

Switzerland2%

Other23%

Major Foreign Holders of Treasury Securities 2011

Percentage of Federal Securities owned by Federal Reserve

2006 2007 2008 2009 20100

1

2

3

4

5

6

7

8

9

10

http://www.fms.treas.gov/bulletin/index.html

Public issues held by the Federal Reserve banks have been revised to exclude the following Government-Sponsored Enterprises: Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and the Federal Home Loan Bank System.

Estimated Ownership of U.S. Treasury Securities

2001-1

2001-3

2002-1

2002-3

2003-1

2003-3

2004-1

2004-3

2005-1

2005-3

2006-1

2006-3

2007-1

2007-3

2008-1

2008-3

2009-1

2009-3

2010-1

2010-30.00

2,000.00

4,000.00

6,000.00

8,000.00

10,000.00

12,000.00

14,000.00

16,000.00

Total Public DebtFederal Reserve and In-tragovernmental holdings

Holders of US Treasury Securities 1996

Individuals24%

Mutual Funds6%

Banking In-stitutions

8% Insurance Companies

6%

Monetary Authority11%

State and Local Govts

4%

Foreign28%

Pension Funds10%

Other3%

Individuals12%

Mutual Funds

7% Banking

Institutions3%

Insurance Companies

3%

Federal Reserve

11%

State and Local Govts

6%

Foreign48%

Pension Funds9%

Other2%

Holders of US Treasury Securities 2000

Individuals18% Mutual Funds

7%

Banking Institutions6%

Insurance Com-panies

3%Federal Reserve

16% State and Local Govts5%

Foreign32%

Pension Funds10%

Other2%

Holders of US Treasury Securities 2005

Individuals10%

Mutual Funds6%

Banking Institutions2%

Insurance Com-panies

4%

Federal Reserve16%

State and Local Govts10%

Foreign42%

Pension Funds7%

Other3%

Holders of US Treasury Securities 2010

Individuals12%

Mutual Funds7%

Banking Institu-tions3%

Insurance Companies

3%

Federal Reserve11%

State and Local Govts

6%

Foreign48%

Pension Funds9%

Other2%

Federal Reserve Purchases

1/3/2

007

3/7/2

007

5/9/2

007

7/11/2

007

9/12/2

007

11/14/2

007

1/16/2

008

3/19/2

008

5/21/2

008

7/23/2

008

9/24/2

008

11/26/2

008

1/28/2

009

4/1/2

009

6/3/2

009

8/5/2

009

10/7/2

009

12/9/2

009

2/10/2

010

4/14/2

010

6/16/2

010

8/18/2

010

10/20/2

010

12/22/2

010

2/23/2

0110

200000

400000

600000

800000

1000000

1200000

1400000

1600000

1800000

Fed Agency Debt Mortgage-Backed Securities Purch

Long Term Treasury Purchases

Lending to Financial Institu-tions

Liquidity to Key Credit Markets

Federal Reserve Custody Accounts

‘Narrow Banking’ and Basic Income

• Whatever money the Treasury does not capture in tax revenue, it must borrow (it cannot simply ‘print money’- only the Fed and private banks have the power to do that.)

• We owe “ourselves” (i.e. domestic bondholders). Therefore, much of the debt is illusory: the Treasury could simply spend debt-free money directly into circulation, rather than loaning it into circulation.

• We do not have to borrow money.

‘Narrow Banking’ and Basic Income

• One solution, proposed originally during FDR’s administration and supported by a majority of economists (including Irving Fisher) is 100% reserves, or ‘narrow banking’:

1. Nationalize the Federal Reserve (incorporate into the Treasury). Money creation will be a power delegated solely to the Federal Government.

2. Ban fractional reserve banking- banks will serve as depository institutions, as people think they do already. The function of credit and money creation will be separated.