Category: US & Canada

Amir Sufi, professor of Finance at the University of Chicago, testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs Subcommittee on Economic Policy. His statement titled “Who is the Economy Working For? The Impact of Rising Inequality on the American Economy” makes interesting reading.

“Only 76% of Americans aged 25 to 54 currently have jobs, compared to 80% in 2006 and 82% in 1999…..How did we get into this mess?”

The gist of his argument is:

“Richer Americans save a much higher fraction of their income, ultimately holding most of the financial assets in the economy: stocks, bonds, money-market funds, and deposits. These savings are lent by banks to middle and lower income Americans, primarily through mortgages.”

…And collapse of the housing market caused disproportionate harm to the middle and lower-income groups.

It is true is that middle and lower-income groups have a higher percentage of their wealth invested in their homes and are also far more exposed to mortgages than richer Americans. The source of funding for these mortgages, however, is not the wealthy — who are primarily invested in growth assets such as stocks — but the banks who create new credit out of thin air. The collapse of the housing market caused disproportionate hardship to middle and lower-income Americans because their wealth is concentrated in this area. The rich suffered from a collapse in stock prices, but the market has recovered to new highs while housing remains in the doldrums. That is one of the causes of rising wealth inequality.

Where I do agree with Amir is that credit growth without income growth is a recipe for disaster.

“A tempting solution to our current troubles is to encourage even more borrowing by lower and middle-income Americans. This group of Americans is likely to spend out of additional credit, which would provide a temporary boost to consumption. But unless borrowing is predicated on higher income growth, we risk falling into the same trap that led to economic catastrophe.”

The graph below compares credit growth to growth in (nominal) disposable income:

The ratio of credit to disposable income rose from 2:1 during the 1960s to almost 5:1 in 2009.

There is no easy path back to the stability of the 1960s. A credit contraction of that magnitude would destroy the economy. But regulators should aim to keep credit growth below the rate of income growth over the next few decades, gradually restoring the economy to a more sustainable level.

The worst possible policy would be to encourage another credit boom!