I don’t buy the argument that the middle classes had to borrow more money to maintain their “middle classness.” They borrowed money as a way of leveraging their investments in stocks (1920s) and real estate (2000s) during a sustained period of soaring values (largely speculatively driven) in an effort to get rich, which, after all, is the American dream.
1928 and 1929 witnessed a spectacular run up in the value of utility stocks, especially electric stocks which, in modern parlance, were perceived as having a lot of “blue sky” as more and more labor saving household electrical devices were invented. Continuously rising stock prices meant investors could purchase stock on margin. When the bull market started to correct itself and stock values began to fall, investors couldn’t make the margin calls and the market collapsed.
Something very similar happened to the residential real estate market in 2007. Unusually low interest rates and liberal lending practices made it possible for the middle classes to massively leverage their investments in real estate. To the extent home buyers were able to finance 80%, 90%, even 100% of their investments, they were effectively purchasing real estate on margin. It was the speculative purchase of real estate by the middle classes that drove home prices up and average of 40% between 2002 and 2006, not the upper class which preferred to invest its money in stocks, hedge funds and money market accounts.
Over the course of the 1990s an average of half a million new homes were built a year. In 2006 over one and a half million new homes were built in response to the demand generated by the extension of vast amounts of credit to hundreds of thousands of individuals, many of which would not have qualified for a new car loan just a few years earlier.
To the extent home equity came to replace “savings” as the main preserve of middle-class wealth in the US, the collapse of the sub-prime mortgage market and ensuing market correction effectively wiped out the savings of the middle classes in 2007.
By contrast, it was not the collapse of the stock market that wiped out the middle classes in 1929 but rather wide-scale bank failure resulting from a run on banks triggered by the failure of the Bank of United States located in New York in 1930 and compounded by misguided monetarist policies (Hoover incorrectly believed the run up in stock values preceding the collapse was the result of there being too much money in circulation).
Because the America Bank technically operated outside the purview of the federal banking system, the Federal Bank refused to lend it the money it needed to overcome a momentary shortage of liquidity and the bank collapsed. Unlike most New York City banks which tended to cater to the upper classes, the America Bank was popular with the middle and lower-middle classes, especially immigrants. Its spectacular collapse wiped out the savings of tens of thousands of people, thereby undermining confidence on the banking system on the part of the middle classes which lined up at banks across America to withdraw their money.
In a similar way the Federally sanctioned collapse of Lehman Brothers in 2007 triggered a lack of confidence in the international banking system, this time on the part of the international banking community itself, with the result that banks stopped lending to one another.
The current economic recession, which was limited to the West–China, India, Brazil and much of the “Third World” continued to enjoy healthy rates of economic growth–was the direct result of a massive ponzi scheme conceived and executed by a handful of US investment bankers. Credit default-swaps and other derivatives (including sub-prime mortgage backed securities) defrauded thousands of investment funds of billions of dollars and destroyed hundreds of formally sound financial institutions. The opaque nature of these investments meant investors had to rely on the very same investment bankers getting rich of the sale of derivatives to determine their value. It was a classic example of the dog guarding the hen house suddenly developing an appetite for raw fowl. Because the values was largely a function of risk, there was a tendency to vastly underestimate risk in the interest of duping investors into accepting a lower rate of return.
In other words, at some point during the first decade of the 21st century, investment bankers decided that repackaging junk as investment grade securities and pocketing the spread was an acceptable business practice.
In doing so they betrayed their clients’ trust and did irreparable harm to the economies of the West and may very well have undermined the ability of the world’s greatest democracy and free market economy to defend and promulgate those very institutions that enabled a class of ultra rich and powerful investment bankers to evolve in the first place.
Nothing like this happened before or during the Great Depression.
To say that Robert Reich “takes short cuts with his facts” is a jewel of understatement. I’ll see if I can scare up more time to respond to [the above] cogent analysis later, but now must put nose to grindstone to earn money so that it can be taken away from me by the government.
The one thing I will say now is that consumers were not blameless in the real estate bubble. A substantial contributing factor — as in all bubbles — was rampant speculation and irresponsible behavior, not just by a few bankers, but by large numbers of consumers. Plenty of blame to go around — as in all bubbles.